<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-K
(Mark One)

    [X]          ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
          OF THE SECURITIES AND EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
                                       OR
    [ ]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
               SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
       For the transition period from _______________ to _______________

                         Commission file number 1-10311

                         KANEB PIPE LINE PARTNERS, L.P.

             (Exact name of Registrant as specified in its Charter)


                Delaware                                   75-2287571
----------------------------------------               -------------------
    (State or other jurisdiction of                      (IRS Employer 
     incorporation or organization)                    Identification No.)

     2435 North Central Expressway
           Richardson, Texas                                 75080
----------------------------------------               -------------------
(Address of principal executive offices)                     (zip code)


       Registrant's telephone number, including area code: (972) 699-4000

          Securities registered pursuant to Section 12(b) of the Act:


                                              Name of each exchange
     Title of each class                       on which registered
   -----------------------                   -----------------------
   Senior Preference Units                   New York Stock Exchange
       Preference Units                      New York Stock Exchange


        Securities registered pursuant to Section 12(g) of the Act: None

     Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes  X  No
                                              ---    ---

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Subsection 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part
III of this Form 10-K or any amendment to this Form 10-K.[ ]

     Aggregate market value of the voting units held by non-affiliates of the
registrant: $310,142,490. This figure is estimated as of March 10, 1997, at
which date the closing price of the Registrant's Senior Preference Units on the
New York Stock Exchange was $30.25 per unit and the closing price of the
Registrant's Preference Units on the New York Stock Exchange was $27.675, and
assumes that only the General Partner of the Registrant and officers and
directors of the General Partner of the Registrant were affiliates.

     Number of Senior Preference Units of the Registrant outstanding at March
10, 1997: 7,250,000. Number of Preference Units of the Registrant outstanding
at March 10, 1997: 4,650,000.


<PAGE>   2
                                     PART I

ITEM I. BUSINESS

GENERAL

     The pipeline system of Kaneb Pipe Line Company was initially created in
1953. In September 1989, Kaneb Pipe Line Partners, L.P. (the "Partnership"), a
Delaware limited partnership, was formed to acquire, own and operate the
refined petroleum products pipeline business (the "East Pipeline") previously
conducted by Kaneb Pipe Line Company, a Delaware corporation ("KPL" or the
"Company"), a wholly owned subsidiary of Kaneb Services, Inc., a Delaware
corporation ("Kaneb"). KPL owns a combined 2% interest as general partner of
the Partnership and of Kaneb Pipe Line Operating Partnership, L.P., a Delaware
limited partnership ("KPOP"). The pipeline operations of the Partnership are
conducted through KPOP, of which the Partnership is the sole limited partner
and KPL is the sole general partner. The terminaling business of the
Partnership is conducted through (i) Support Terminals Operating Partnership,
L.P. ("STOP"), (ii) Support Terminal Services, Inc., (iii) StanTrans, Inc.,
(iv) StanTrans Partners L.P. ("STPP"), and (v) StanTrans Holdings, Inc. KPOP,
STOP and STPP are collectively referred to as the "Operating Partnerships".

     The Partnership is engaged, through its Operating Partnerships, in the
refined petroleum products pipeline business and the terminaling of petroleum
products and specialty liquids.

PRODUCTS PIPELINE BUSINESS

     Introduction

     The Partnership's pipeline business consists primarily of the
transportation, as a common carrier, of refined petroleum products in Kansas,
Nebraska, Iowa, South Dakota, North Dakota, Colorado and Wyoming. The
Partnership owns and operates two common carrier pipelines (the "Pipelines") as
shown on the map below:

                                     [MAP]


                                       2

<PAGE>   3

     East Pipeline

     Construction of the East Pipeline commenced in the 1950's with a line from
southern Kansas to Geneva, Nebraska.  During the 1960's, the East Pipeline was
expanded north to its present terminus at Jamestown, North Dakota. In 1981, the
line from Geneva, Nebraska to North Platte, Nebraska was built and, in 1982,
the 16" line from McPherson, Kansas to Geneva, Nebraska was built.  In 1984,
the Partnership acquired a 6" pipeline from Champlin Oil Company.  A portion of
this line runs south from Shickley, Nebraska through Superior, Nebraska, to
Hutchinson, Kansas.  The Partnership is building a new 6" pipeline from Conway,
Kansas to Windom, Kansas (approximately 22 miles north of Hutchinson) that will
allow the Hutchinson Terminal to be supplied directly from McPherson; a
significantly shorter route than currently used.  Once the new pipeline is
operational (anticipated to be April 1997), the segment of the old Champlin
line between Windom and Shickley will be shut down.  The other end of the line
runs northeast approximately 175 miles crossing the main pipeline at Osceola,
Nebraska, through a terminal at Columbus, Nebraska, and later crossing and
interconnecting with the Partnership's Yankton/Milford line to terminate at
Rock Rapids, Iowa.

     The East Pipeline system also consists of 16 product terminals in Kansas,
Nebraska, Iowa, South Dakota and North Dakota (with total storage capacity of
approximately 3.2 million barrels) and an additional 23 product tanks with
total storage capacity of approximately 922,000 barrels at its tank farm
installations at McPherson and El Dorado, Kansas. The system further has six
origin pump stations at refineries in Kansas and 38 booster pump stations
situated along the system in Kansas, Nebraska, Iowa, South Dakota and North
Dakota.  Additionally, the system maintains various office and warehouse
facilities, and an extensive quality control laboratory.  KPOP owns the entire
2,075 mile East Pipeline, except for the 203-mile North Platte line, which is
held under a capitalized lease that expires at the end of 1998 and which
provides rights to renew the lease for an additional five years.  At the end of
the lease term, KPOP has the option to purchase the North Platte line for
approximately $5 million or, if such option is not exercised, the lessor can
require KPOP to purchase the line at a lower price.  KPOP leases office space
for its operating headquarters in Wichita, Kansas.

     The East Pipeline is a pipeline transporting refined petroleum products,
including propane, received from refineries in southeast Kansas and other
connecting pipelines to terminals in Kansas, Nebraska, Iowa, South Dakota and
North Dakota and to receiving pipeline connections in Kansas.  Shippers on the
East Pipeline obtain refined petroleum products from refineries connected to
the East Pipeline directly or through other pipelines. These refineries obtain
their crude oil primarily from producing areas in Kansas, Oklahoma and Texas.
Five connecting pipelines can deliver propane for shipment through the East
Pipeline from gas processing plants in Texas, New Mexico, Oklahoma and Kansas.

     West Pipeline

     KPOP acquired the West Pipeline in February 1995 through an asset purchase
from WYCO Pipe Line Company for a purchase price of $27.1 million.  The
acquisition of the West Pipeline increased the Partnership's pipeline business
in South Dakota and expanded it into Wyoming and Colorado.  The West Pipeline
system includes approximately 550 miles of underground pipe line in Wyoming,
Colorado and South Dakota, four truck loading terminals and numerous pump
stations situated along the system.  The system has four product terminals
having a total storage capacity of over 1.7 million barrels.

     The West Pipeline originates at Casper, Wyoming. Strouds station, which is
located east of Casper in Evansville, Wyoming, serves as a connecting point
with Sinclair's Little America refinery and the Seminoe Pipeline that delivers
product from Billings, Montana area refineries.  From Strouds, the West
Pipeline continues easterly through its 8" line to Douglas, Wyoming, where a 6"
pipeline branches off to serve the Partnership's Rapid City, South Dakota
terminal approximately 190 miles away.  The 6" pipeline also receives product
from Wyoming Refining's pipeline at a connection located near the Wyoming/South
Dakota border approximately 30 miles south of  Wyoming Refining's Newcastle
refinery.  The Rapid City terminal has a three bay bottom loading truck rack
and storage tank capacity of 256,000 barrels.  At Douglas Junction, the
Partnership's 8" pipeline continues southward through a delivery point at the
Burlington Northern Junction to the Cheyenne terminal.  The Cheyenne terminal
has a two bay bottom loading truck rack and storage tank capacity of 345,000
barrels.  The Cheyenne terminal also serves as a receiving point


                                       3

<PAGE>   4



for products from the Frontier refinery.  Products can also be delivered to the
Cheyenne Pipe Line at the Cheyenne terminal.  From the Cheyenne terminal, the
pipeline extends south into Colorado to the Dupont terminal located in the
Denver metropolitan area.  The Dupont terminal is the largest terminal on the
West Pipeline system, with a six bay bottom loading truck rack and tankage
capacity of 692,000 barrels.  The 8" pipeline continues to the Commerce City
station, where the West Pipeline can receive from and transfer product to the
Total Petroleum and Conoco refineries and the Phillips Petroleum terminal. From
the Commerce City station, a 6" line continues south 90 miles where the system
terminates at the Fountain, Colorado terminal.  The Fountain terminal has a
five bay bottom loading truck rack and storage tank capacity of  366,000
barrels.

     The West Pipeline system parallels KPP's East Pipeline to the west.  The
East Pipeline's North Platte line terminates in western Nebraska, approximately
200 miles east of the West Pipeline's Cheyenne, Wyoming terminal.  The small
Cheyenne Pipe Line moves products from west to east from the West Pipeline's
Cheyenne terminal to near the East Pipeline's North Platte terminal, although
that line has been deactivated from Sidney, Nebraska (approximately 100 miles
from Cheyenne) to North Platte.  The West Pipeline serves Denver and other
eastern Colorado markets and supplies jet fuel to Ellsworth Air Force Base at
Rapid City, South Dakota, as compared to the East Pipeline's largely
agricultural service area. The West Pipeline has a relatively small number of
shippers, who, with few exceptions, are also shippers on the Partnership's East
Pipeline system.

     Pipelines Products and Activities

     The Pipelines' revenues are based on volumes shipped and the distances
over which such volumes are transported.  The following table reflects the
total volume and barrel miles of refined petroleum products shipped and total
operating revenues earned by the East Pipeline for each of the periods
indicated and by the West Pipeline since its acquisition on February 24, 1995.

<TABLE>
<CAPTION>
                                         YEAR ENDED DECEMBER 31,
                            ----------------------------------------------------
                              1992       1993       1994       1995       1996
                            --------   --------   --------   --------   --------
<S>                         <C>        <C>        <C>        <C>        <C>     
Volume (1) ..............     55,111     56,234     54,546     74,965     73,839
Barrel miles (2) ........     14,287     14,160     14,460     16,594     16,735
Revenues (3) ............   $ 42,179   $ 44,107   $ 46,117   $ 60,192   $ 63,441
</TABLE>

(1)  Volumes are expressed in thousands of barrels of refined petroleum
     product.
(2)  Barrel miles are shown in millions. A barrel mile is the movement of one
     barrel of refined petroleum product one mile.
(3)  Revenues are expressed in thousands of dollars.

     The following table sets forth volumes of gasoline, diesel and fuel oil,
propane and other refined petroleum products transported by the East Pipeline
during each of the periods indicated and by the West Pipeline since its
acquisition by the Partnership in February 1995.

<TABLE>
<CAPTION>
                                               YEAR ENDED DECEMBER 31,
                                               (THOUSANDS OF BARRELS)
                                      ------------------------------------------
                                       1992     1993     1994     1995     1996
                                      ------   ------   ------   ------   ------
<S>                                   <C>      <C>      <C>      <C>      <C>   
Gasoline ..........................   24,816   25,407   23,958   37,348   36,063
Diesel and fuel oil ...............   23,374   25,308   26,340   33,411   32,934
Propane ...........................    4,676    4,153    4,204    4,146    4,842
Other .............................    2,245    1,366       44       60      -0-
                                      ------------------------------------------
  Total ...........................   55,111   56,234   54,546   74,965   73,839
                                      ======   ======   ======   ======   ======
</TABLE>

     Diesel and fuel oil are used in farm machinery and equipment,
over-the-road transportation, railroad fueling and residential fuel oil.
Gasoline is primarily used in over-the-road transportation. Propane is used for
crop drying, residential heating and to power irrigation equipment. The mix of
refined petroleum products delivered


                                       4

<PAGE>   5



varies seasonally, with gasoline demand peaking in early summer, diesel fuel
demand peaking in late summer and propane demand higher in the fall.  In
addition, weather conditions in the markets served by the East Pipeline affect
the demand for and the mix of the refined petroleum products delivered through
the East Pipeline, although historically any impact on the volumes shipped has
been short-term.  Tariffs charged shippers for transportation do not vary
according to the type of product delivered.

     In October, 1991, two single-use pipelines were acquired from Calnev Pipe
Line Company for $2.65 million. Each system, one located in Umatilla, Oregon
and the other in Rawlins, Wyoming, supplies diesel fuel to Union Pacific
Railroad fueling facilities under contracts having an initial term of five
years, expiring in October 1996.  These contracts were automatically renewed
for two years and are renewable thereafter for successive two year terms unless
canceled by either party.  The Oregon line is fully automated and the Wyoming
line requires minimal start-up assistance, which is provided by the railroad.
In May 1993, KPOP began operating a newly constructed single-use pipeline near
Pasco, Washington which supplies diesel fuel to a Burlington Northern Railroad
fueling facility.  For the year ended December 31, 1996, the three systems
combined transported a total of 3.5 million barrels of diesel fuel,
representing an aggregate of $1.3 million in revenues.

     Maintenance and Monitoring

     The Pipelines have been constructed and are maintained consistent with
applicable federal, state and local laws and regulations, standards prescribed
by the American Petroleum Institute and accepted industry practice.  Further,
to prolong the useful lives of the Pipelines, routine preventive maintenance is
performed.  Such maintenance includes cathodic protection to prevent external
corrosion and inhibitors to prevent internal corrosion, periodic inspection of
the Pipelines and frequent patrols of the Pipelines' rights-of-way.  The
Pipelines are patrolled at regular intervals to identify equipment or
activities by third parties that, if left unchecked, could result in
encroachment of the Pipelines and other problems.

     Supervisory Control and Data Acquisition ("SCADA"), a remote supervisory
control software program, continuously monitors the Pipelines from the Wichita,
Kansas headquarters.  The system monitors quantities of refined petroleum
products injected in and delivered through the Pipelines and automatically
signals the Wichita headquarters of any deviation from normal operations that
requires attention.  A new, state-of-the-art SCADA system was installed and in
operation on the West Pipeline as of October 1995 and was completed on the East
Pipeline during January 1997.

     Pipeline Operations

     Both the East Pipeline and the West Pipeline are interstate pipelines and
thus subject to federal regulation by such governmental agencies as the Federal
Energy Regulatory Commission ("FERC") and the Department of Transportation.
Additionally, the West Pipeline is subject to state regulation of certain
intrastate rates in Colorado and Wyoming and the East Pipeline is subject to
state regulation in Kansas.  The Pipelines are also subject to the regulations
of other governmental agencies such as the Environmental Protection Agency.
(See:  "Regulation")

     Except for the three single-use pipelines and certain ethanol facilities,
all of the Partnership's pipeline operations constitute common carrier
operations and are subject to federal tariff regulation.  Also, certain of its
intrastate common carrier operations are subject to state tariff regulation.
Common carrier activities are those under which transportation through the
Pipelines are available at published tariffs filed with the FERC, in the case
of interstate shipments, or the relevant state authority, in the case of
intrastate shipments in Kansas, Colorado and Wyoming, to any shipper of refined
petroleum products who requests such services and satisfies the conditions and
specifications for transportation.

     In general, a shipper on one of the Pipelines acquires refined petroleum
products from refineries connected to such Pipeline, or, if the shipper already
owns the refined petroleum products, delivers such products to the Pipeline
from those refineries or through pipelines that connect with such Pipeline.
Tariffs for transportation are charged to shippers based upon transportation
from the origination point on the Pipeline to the point of delivery.  Such
tariffs also include charges for terminaling and storage of product at the
Pipeline's terminals.  Pipelines are generally the lowest cost method for
intermediate and long-haul overland transportation of refined petroleum
products.


                                       5

<PAGE>   6



     Each shipper transporting product on a Pipeline is required to supply KPOP
with a notice of shipment indicating sources of products and destinations.  All
shipments are tested or receive refinery certifications to ensure compliance
with KPOP's specifications.  Shippers are generally invoiced by KPOP
immediately upon the product entering one of the Pipelines.  The operations of
the Pipelines include 20 truck loading terminals through which refined
petroleum products are delivered to petroleum transport trucks.

     The following table shows, with respect to each of such terminals, its
location, the number of tanks owned by KPOP, its storage capacity in barrels
and truck capacity.  Except as indicated in the notes to the table, each
terminal is owned by KPOP.


<TABLE>
<CAPTION>
                 LOCATION OF     NUMBER    TANKAGE      TRUCK
                  TERMINALS     OF TANKS  CAPACITY   CAPACITY(a)
                --------------  --------  ---------  -----------
                <S>             <C>       <C>        <C>
                COLORADO:
                  Dupont              18    692,000            6
                  Fountain            13    366,000            5

                IOWA:
                  LeMars               9    103,000            2
                  Milford(b)          11    172,000            2
                  Rock Rapids         12    366,000            2

                KANSAS:
                  Concordia(c)         7     79,000            2
                  Hutchinson           9    162,000            1

                NEBRASKA:
                  Columbus(d)         12    191,000            2
                  Geneva              39    678,000            8
                  Norfolk             16    187,000            4
                  North Platte        22    198,000            5
                  Osceola              8     79,000            2
                  Superior(e)         11    192,000            1

                NORTH DAKOTA:
                  Jamestown           13    188,000            2

                SOUTH DAKOTA:
                  Aberdeen            12    181,000            2
                  Mitchell             8     72,000            2
                  Rapid City          13    256,000            3
                  Wolsey              21    149,000            4
                  Yankton             25    246,000            4

                WYOMING:
                  Cheyenne            15    345,000            2
                                --------  ---------
                TOTALS               294  4,902,000
                                ========  =========
</TABLE>

--------------
(a)  Number of trucks that may be simultaneously loaded.
(b)  The Milford terminal is situated on land leased through August 7, 2007 at
     an annual rental of $2,400. KPOP has the right to renew the lease upon its
     expiration for an additional term of 20 years at the same annual rental
     rate.
(c)  The Concordia terminal is situated on land leased through the year 2060
     for a total rental of $2,000.
(d)  Also loads rail tank cars.
(e)  Out of service as of March 15, 1997.


                                       6

<PAGE>   7

     The East Pipeline includes intermediate storage facilities consisting of
13 storage tanks at El Dorado, Kansas and 10 storage tanks at McPherson, Kansas
with aggregate capacities of approximately 388,000 and 534,000 barrels,
respectively. During 1996, approximately 60% and 92% of the deliveries of the
East Pipeline and the West Pipeline, respectively, were made through their
terminals, and approximately 40% and 8% of the respective deliveries of such
lines were made to other pipelines and customer owned storage tanks.

     Storage of product at terminals pending delivery is considered by the
Partnership to be an integral part of the product delivery service of the
Pipelines.  Shippers generally store refined petroleum products for less than
one week.  Ancillary services, including injection of shipper-furnished and
generic additives, are available at each terminal.

     Demand for and Sources of Refined Petroleum Products

     The Partnership's pipeline business depends in large part on (i) the level
of demand for refined petroleum products in the markets served by the Pipelines
and (ii) the ability and willingness of refiners and marketers having access to
the Pipelines to supply such demand by deliveries through the Pipelines.

     Most of the refined petroleum products delivered through the East Pipeline
are ultimately used in agricultural operations, including fuel for farm
equipment, irrigation systems, trucks transporting crops and crop drying
facilities. Demand for refined petroleum products for agricultural use, and the
relative mix of products required, is affected by weather conditions in the
markets served by the East Pipeline.  The agricultural sector is also affected
by government agricultural policies and crop prices.  Although periods of
drought suppress agricultural demand for some refined petroleum products,
particularly those used for fueling farm equipment, during such times the
demand for fuel for irrigation systems often increases.

     While there is some agricultural demand for the refined petroleum products
delivered through the West Pipeline, as well as military jet fuel volumes, most
of the demand is centered in the Denver and Colorado Springs/Fountain areas.
Because demand on the West Pipeline is significantly weighted toward urban and
suburban areas, the product mix on the West Pipeline includes a substantially
higher percentage of  gasoline than the product mix on the East Pipeline.

     The Pipelines are also dependent upon adequate levels of production of
refined petroleum products by refineries connected to the Pipelines, directly
or through connecting pipelines.  The refineries are, in turn, dependent upon
adequate supplies of suitable grades of crude oil.  The refineries connected
directly to the East Pipeline obtain crude oil from producing fields located
primarily in Kansas, Oklahoma and Texas, and, to a much lesser extent, from
other domestic or foreign sources. Refineries in Kansas, Oklahoma and Texas are
connected to the East Pipeline through other pipelines.  These refineries
obtain their supplies of crude oil from a variety of sources.  The refineries
connected directly to the West Pipeline are located in Casper and Cheyenne,
Wyoming and Denver, Colorado. Refineries in Billings and Laurel, Montana are
connected to the West Pipeline through other pipelines.  These refineries
obtain their supplies of crude oil primarily from Rocky mountain sources.  If
operations at any one refinery were discontinued, the Partnership believes
(assuming unchanged demand for refined petroleum products in markets served by
the Pipelines) that the effects thereof would be short-term in nature, and the
Partnership's business would not be materially adversely affected over the long
term because such discontinued production could be replaced by other refineries
or by other sources.

     The majority of the refined petroleum product transported through the East
Pipeline is produced at four refineries located at McPherson, El Dorado and
Arkansas City, Kansas and Ponca City, Oklahoma, and operated by National
Cooperative Refinery Association ("NCRA"), Texaco, Inc. ("Texaco"), Total
Petroleum ("Total") and Conoco, Inc. respectively.  The NCRA, Texaco and Total
refineries are connected directly to the East Pipeline, however, the Total
refinery was shut down on September 1, 1996.  One of such refineries, the
McPherson, Kansas refinery operated by NCRA, accounted for approximately 37% of
the total amount of product shipped over the East Pipeline in 1996.  The East
Pipeline also has direct access by third party pipelines to four other
refineries in Kansas, Oklahoma and Texas and to Gulf Coast supplies of products
through connecting pipelines that receive products from a pipeline originating
on the Gulf Coast.  Five connecting pipelines can deliver propane from gas
processing plants in Texas, New Mexico, Oklahoma and Kansas to the East
Pipeline for shipment.


                                       7

<PAGE>   8



     The majority of the refined petroleum products transported through the
West Pipeline is produced at the Frontier Oil & Refining Company refinery
located at Cheyenne, Wyoming, the Total Petroleum and Conoco Oil refineries
located at Denver, Colorado and Sinclair's Little America refinery located at
Casper, Wyoming, all of which are connected directly to the West Pipeline. The
West Pipeline also has access to three Billings, Montana area refineries
through a connecting pipeline.

     Principal Customers

     KPOP had a total of approximately 52 shippers in 1996.  The principal
shippers include four integrated oil companies, three refining companies, two
large farm cooperatives and one railroad.  Transportation revenues attributable
to the top 10 shippers of the Pipelines were $46.5 million, $43.7 million and
$35.8 million, which accounted for 76%, 75% and 80% of total revenues for each
of the years 1996, 1995 and 1994, respectively.  These amounts were based upon
revenue shipped during the periods indicated.

     Competition and Business Considerations

     The East Pipeline's major competitor is an independent regulated common
carrier pipeline system owned by The Williams Companies, Inc. that operates
approximately 100 miles east of and parallel with the East Pipeline. The
Williams system is a substantially more extensive system than the East
Pipeline.  Furthermore, Williams and its affiliates have capital and financial
resources that are substantially greater than those of the Partnership.
Competition with Williams is based primarily on transportation charges, quality
of customer service and proximity to end users, although refined product
pricing at either the origin or terminal point on a pipeline may outweigh
transportation costs.  Fifteen of the East Pipeline's 16 delivery terminals are
in direct competition with Williams' terminals, as they are located within two
to 145 miles of one another.

     The West Pipeline competes with the truck loading racks of the Cheyenne
and Denver refineries and the Denver terminals of the Chase Pipeline Company
and Phillips Petroleum pipelines.  Diamond Shamrock terminals in Denver and
Colorado Springs, connected to a Diamond Shamrock pipeline from their Texas
Panhandle refinery, are major competitors to the West Pipeline's Denver and
Fountain terminals, respectively.

     Because pipelines are generally the lowest cost method for intermediate
and long-haul movement of refined petroleum products, the Pipelines' more
significant competitors are common carrier and proprietary pipelines owned and
operated by major integrated and large independent oil companies and other
companies in the areas where the Pipelines deliver products.  Competition
between common carrier pipelines is based primarily on transportation charges,
quality of customer service and proximity to end users.  The Partnership
believes high capital costs, tariff regulation, environmental considerations
and problems in acquiring rights-of-way make it unlikely that other competing
pipeline systems comparable in size and scope to the Pipelines will be built in
the near future, provided the Pipelines have available capacity to satisfy
demand and its tariffs remain at reasonable levels.

     The costs associated with transporting products from a loading terminal to
end users limit the geographic size of the market that can be served
economically by any terminal. Transportation to end users from the loading
terminals of the Partnership is conducted principally by trucking operations of
unrelated third parties. Trucks may competitively deliver products in some of
the areas served by the Pipelines. However, trucking costs render that mode of
transportation not competitive for longer hauls or larger volumes. The
Partnership does not believe that trucks are, or will be, over the long term
effective competition to its long-haul volumes.


                                       8

<PAGE>   9



LIQUIDS TERMINALING

     Introduction

     The Partnership's Support Terminal Services, Inc. operation ("ST") is one
of the largest independent petroleum products and specialty liquids terminaling
companies in the United States.  For the year ended December 31, 1996, the
Partnership's terminaling business accounted for approximately 46% of the
Partnership's revenues.  As of December 31, 1996, ST operates 31 facilities in
16 states and the District of Columbia, with a total storage capacity of
approximately 17.2 million barrels.  ST and its predecessors have been in the
terminaling business for 40 years and handle a wide variety of products from
petroleum products to specialty chemicals to edible liquids.

     ST's terminal facilities provide storage on a fee basis for petroleum
products, specialty chemicals and other liquids.  ST's five largest terminal
facilities are located in Piney Point, Maryland; Jacksonville, Florida; Texas
City, Texas; Baltimore, Maryland; and, Westwego, Louisiana.  These facilities
accounted for approximately 75% of ST's revenues and 65% of its tankage
capacity in 1996.

     Description of Terminals

     Piney Point, Maryland. The largest terminal currently owned by ST is
located on approximately 400 acres on the Potomac River.  The facility was
acquired as part of the purchase of the liquids terminaling assets of Steuart
Petroleum Company and certain of its affiliates (collectively "Steuart") in
December 1995 (See:  Recent Developments - Steuart Petroleum Company
Acquisition).  The Piney Point terminal has approximately 5.4 million barrels
of storage capacity in 28 tanks and is the closest deep water facility to
Washington, D.C.  This terminal competes with other large petroleum terminals
in the East Coast water-borne market extending from New York Harbor to Norfolk,
Virginia.  The terminal currently stores petroleum products, consisting
primarily of fuel oils and asphalt.  The terminal has a dock with a 36-foot
draft for tankers and four berths for barges.  It also has truck loading
facilities and product blending capabilities and is connected to a pipeline
which supplies residual fuel oil to two power generating stations.

     Jacksonville, Florida. The Jacksonville terminal, also acquired as part of
the Steuart transaction, is located on approximately 86 acres at the St. John's
River and consists of a main terminal and two annexes with combined storage
capacity of approximately 2.1 million barrels in 28 tanks.  The terminal is
currently used to store petroleum products including gasoline, No. 2 oil, No. 6
oil, diesel and kerosene.  This terminal has a tanker berth with a 38-foot
draft and six barge berths and also offers truck and rail car loading
facilities and facilities to blend residual fuels for ship bunkering.

     Texas City, Texas.  The Texas City facility is situated on 39 acres of
land leased from the Texas City Terminal Railway Company ("TCTRC") with
long-term renewal options.  It is located on Galveston Bay near the mouth of
the Houston Ship Channel, approximately sixteen miles from open water.  The
eastern end of the Texas City site is adjacent to three deep-water docking
facilities, which are also owned by TCTRC.  The three deep-water docks include
two 36-foot draft docks and a 40-foot draft dock.  The docking facilities can
accommodate any ship or barge capable of navigating the 40-foot draft of the
Houston Ship Channel.  ST is charged dockage and wharfage fees on a per vessel
and per unit basis, respectively, by TCTRC, which it passes directly to its
customers.

     ST handles and stores a wide range of specialty chemicals, including
petrochemicals, at the Texas City facility. The facilities are designed to
accommodate a diverse product mix, and include (i) tanks equipped for the
specific storage needs of the various products handled;  (ii) piping and
pumping equipment for moving the product between the tanks and the
transportation modes; and, (iii) an extensive infrastructure of support
equipment.  The tankage at Texas City is constructed of either mild carbon
steel, stainless steel or aluminum.  Certain of the tanks, piping and pumping
equipment are equipped for special product needs, including among other things,
linings and/or equipment that can control temperature, air pressure, air
mixture or moisture.  ST receives or delivers the majority of the specialty
chemicals that it handles via ship or barge at Texas City.  ST also receives
and delivers liquids via rail tank cars and transport trucks and has direct
pipeline connections to refineries in Texas City.


                                       9

<PAGE>   10



     The Texas City terminal consists of 124 tanks with a total capacity of
approximately 2 million barrels. All recently built tanks are equipped with
"double bottoms", which provide a leak detection system between the primary and
secondary bottom. ST's facility has been designed with engineered structural
measures to minimize the possibility of the occurrence and the level of damage
in the event of a spill or fire. All loading areas, tanks, pipes and pumping
areas are "contained" to collect any spillage and insure that only properly
treated water is discharged from the site.

     Baltimore, Maryland.  The Baltimore facility is situated on 18 acres of
owned land, located just south of Baltimore near the Harbor Tunnel on the
Chesapeake Bay.  ST also owns a 700-foot finger pier with a 33-foot draft
channel and berth at the facility.  The dock gives ST the ability to receive
and deliver shipments of product from and to barge and ship.  Additionally, the
terminal can receive products by pipeline, truck and rail and deliver them via
truck and rail.  Similar to the Texas City facility, Baltimore is a specialty
liquids terminal.  The primary products stored at the Baltimore facility
include asphalt, fructose, caustic solutions, military jet fuel, latex and
other chemicals.  The Baltimore tank facility consists of 50 tanks with a total
capacity of approximately 826,000 barrels.  All of the utilized tanks are
dedicated to specific products of customers under contract.  The tanks are
specifically equipped to handle the requirements of the products they store.

     Westwego, Louisiana.  The Westwego facility is situated on 27 acres of
owned land adjacent to the West bank of the Mississippi River across from New
Orleans.  Its dock is capable of handling ocean-going vessels and barges.  The
terminal has numerous handling facilities for receiving and shipping by rail
and tank truck, as well as vessels and barges.  The Westwego terminal
historically has been primarily a terminal for molasses and animal and
vegetable fats and oils.  The former owner of the facility has contracted with
ST until June 1999 for terminaling in five large molasses tanks.  In recent
years, the terminal has broadened its product mix to include fertilizer, latex
and caustic solutions.  The facility includes a blending plant for the
formulation of certain molasses-based feeds.  The facility consists of 54 tanks
with a total capacity of approximately 858,000 barrels.  There are additional
smaller tanks for blending and formulation of the liquid feeds.

     Other Terminal Sites.   In addition to the five major facilities described
above, ST has 26 other terminal facilities located throughout the United
States, not separately counting two terminal facilities acquired in 1996 that
are adjacent to facilities that were already owned by the Partnership (See:
Recent Developments).  The 26 facilities represented approximately 35% of ST's
total tankage capacity and approximately 25% of its total revenue for 1996.
With the exception of the facilities in Columbus, Georgia, which handles
aviation gasoline and specialty chemicals, Winona, Minnesota, which handles
nitrogen fertilizer solutions, and Savannah, Georgia which handles chemicals
and caustic, these facilities primarily store petroleum products for a variety
of customers.  These facilities provide ST with a geographically diverse base
of customers and revenue.

     The storage and transport of jet fuel for the U.S. Department of Defense
is also an important part of ST's business.  Ten of ST's terminal sites are
involved in the terminaling or transport (via pipeline) of jet fuel for the
Department of Defense.  Six of the ten locations are utilized solely by the
U.S. Government.  Five of the locations include pipelines which deliver jet
fuel directly to nearby military bases.  Additionally, a sixth location is the
former Steuart facility supplying Andrews Air Force Base, Maryland, consists of
a barge receiving dock, an 11.3 mile pipeline, three 24,000 barrel
double-bottomed tanks and an administration building located on the base.  This
facility provides the barge receipt, pipeline transportation and terminaling
services for jet fuel to Andrews Air Force Base on a tariff basis for the
Defense Fuel Supply Center and has served the base for the past 30 years.


                                       10

<PAGE>   11



The following table outlines ST's terminal locations, capacities, tanks and
primary products handled:


<TABLE>
<CAPTION>
                             TANKAGE         NO. OF      PRIMARY PRODUCTS
   FACILITY                  CAPACITY         TANKS          HANDLED
---------------------------------------------------------------------------------
<S>                       <C>                <C>     <C>
PRIMARY TERMINALS:
Piney Point, MD             5,403,000           28   Petroleum
Jacksonville, FL            2,061,000           28   Petroleum
Texas City, TX              2,002,000          124   Chemicals and Petrochemicals
Westwego, LA                  858,000           54   Molasses, Fertilizer, Caustic
Baltimore, MD                 826,000           50   Chemicals, Asphalt, Jet Fuel

OTHER TERMINALS:
Montgomery, AL(a)             162,000            7   Petroleum, Jet Fuel
Moundville, AL                310,000            6   Jet Fuel
Tuscon, AZ(b)                 181,000            7   Petroleum
Imperial, CA                  124,000            6   Petroleum
Stockton, CA                  314,000           18   Petroleum
Farragut St., DC              176,000            5   Petroleum
M Street, DC                  133,000            3   Petroleum
Homestead, FL(a)               72,000            2   Jet Fuel
Augusta, GA                   110,000            8   Petroleum
Bremen, GA                    180,000            8   Petroleum, Jet Fuel
Brunswick, GA                 302,000            3   Petroleum, Pulp Liquor
Columbus, GA                  180,000           25   Petroleum, Chemicals
Macon, GA(a)                  307,000           10   Petroleum
Savannah, GA                  696,000           17   Petroleum, Chemicals
Chillicothe, IL               270,000            6   Petroleum
Peru, IL                      221,000            8   Petroleum, Fertilizer
Indianapolis, IN              410,000           18   Petroleum
Salina, KS                     98,000           10   Petroleum
Andrews AFB Pipeline, MD       72,000            3   Jet Fuel
Winona, MN                    229,000            7   Fertilizer
Alamogordo, NM(a)             120,000            5   Jet Fuel
Drumright, OK                 315,000            4   Jet Fuel
San Antonio, TX               207,000            4   Jet Fuel
Cockpit Point, VA             545,000           16   Petroleum, Asphalt
Virginia Beach, VA(a)          40,000            2   Jet Fuel
Milwaukee, WI                 308,000            7   Petroleum
                           ----------   ----------
                           17,232,000          499
                           ==========   ==========
</TABLE>

(a)  Facility also includes pipelines to U.S. government military base
     locations.
(b)  The terminal is 50% owned by ST.



                                       11

<PAGE>   12
     Recent Developments

     Steuart Petroleum Company Acquisition

     In December 1995, the Partnership, through its subsidiary partnership
STOP, acquired the liquids terminaling assets of Steuart Petroleum Company and
certain of its affiliates (collectively "Steuart") for $68 million and the
assumption of certain environmental liabilities.  The Steuart terminaling
assets acquired in the transaction consisted of eight facilities located in the
District of Columbia, Florida, Georgia, Maryland and Virginia, including the
pipeline servicing Andrews Air Force Base in Maryland.  Strategically, the
Steuart acquisition allowed the Partnership to significantly increase its
presence on the East Coast of the United States, which has been further
enhanced by the Powell-Duffryn and Sun acquisitions described below.

     Powell-Duffryn Acquisition

     In October 1996, the Partnership, through STOP, acquired a chemical
liquids terminaling facility located in Savannah, Georgia from Powell-Duffryn,
Inc. for $2.5 million plus transaction costs and the assumption of certain
environmental liabilities.  The terminal facility consists of five tanks having
a total capacity of approximately 389,000 barrels and is also close to an
existing petroleum terminal that was acquired by the Partnership in the Steuart
acquisition.  The acquisition of the Powell-Duffryn facility expanded the size,
customer base and range of services provided by ST in Savannah, as it handles
chemicals and caustic solutions rather than the petroleum products historically
handled at the Partnership's existing Savannah terminal.

     Cockpit Point Acquisition

     In December 1996, the Partnership, through STOP, acquired an asphalt
terminal in Cockpit Point, Virginia from Sun Company, Inc. (R&M) for $5.0
million plus transaction costs.  The terminal is also adjacent to an existing
facility, that was acquired by the Partnership in the Steuart acquisition and
added 12 tanks having a total storage capacity of 89,000 barrels to the
Partnership's existing operations at Cockpit Point.  Until January 1, 1997, ST
provided terminaling for Sun, at which time CITGO Asphalt Refining Company
commenced using the terminal under a long term agreement with ST for the
terminaling of CITGO's asphalt products.  The acquisition was financed under
the Partnership's $15 existing million revolving bank credit facility.

     Competition and Business Considerations

     In addition to the terminals owned by independent terminal operators, such
as ST, many major energy and chemical companies own extensive terminal storage
facilities.  Although such terminals often have the same capabilities as
terminals owned by independent operators, they generally do not provide
terminaling services to third parties.  In many instances, major energy and
chemical companies that own storage and terminaling facilities are also
significant customers of independent terminal operators.  Such companies
typically have strong demand for terminals owned by independent operators when
independent terminals have more cost effective locations near key
transportation links, such as deep-water ports.  Major energy and chemical
companies also need independent terminal storage when their owned storage
facilities are inadequate, either because of size constraints, the nature of
the stored material or specialized handling requirements.

     Independent terminal owners generally compete on the basis of the location
and versatility of terminals, service and price.  A favorably located terminal
will have access to various cost effective transportation modes both to and
from the terminal.  Possible transportation modes include waterways, railroads,
roadways and pipelines.  Terminals located near deep-water port facilities are
referred to as "deep-water terminals" and terminals without such facilities are
referred to as "inland terminals"; though some inland facilities are served by
barges on navigable rivers.

     Terminal versatility is a function of the operator's ability to offer
handling for diverse products with complex handling requirements.  The service
function typically provided by the terminal includes, among other things, the
safe storage of the product at specified temperature, moisture and other
conditions, as well as receipt at and delivery from the terminal.  An
increasingly important aspect of versatility and the service function is an
operator's ability to offer


                                       12

<PAGE>   13



product handling and storage in compliance with environmental regulations.  A
terminal operator's ability to obtain attractive pricing is often dependent on
the quality, versatility and reputation of the facilities owned by the
operator.  Although many products require modest terminal modification,
operators with a greater diversity of terminals with versatile storage
applications typically require less modification prior to usage, ultimately
making the storage cost to the customer more attractive.

     Several companies offering liquid terminaling facilities have
significantly more capacity than ST. However, the majority of ST's tankage can
be described as "niche" facilities that are equipped to properly handle
"specialty" liquids or provide facilities or services where management believes
they enjoy an advantage over competitors.  Most of the larger operators,
including GATX Terminals Corporation, Williams, Northville Industries
Corporation and Petroleum Fuel & Terminal Company, have facilities used
primarily for petroleum related products.  As a result, most of Steuart's
terminals will be competing against other large petroleum products terminals
rather than the specialty liquids facilities offered by tankage at ST's
terminals.  Such specialty or "niche" tankage is less abundant in the U.S. and
"specialty" liquids typically command higher terminal fees than lower-price
bulk terminaling for petroleum products.

CAPITAL EXPENDITURES

     Capital expenditures by the Pipelines, were $2.2 million, $3.4 million and
$3.5, respectively, for the three years ended from December 31, 1994 to
December 31, 1996.  During these periods, adequate Pipeline capacity existed to
accommodate volume growth and the expenditures required for environmental and
safety improvements were not material in amount.  Capital expenditures,
excluding acquisitions, by ST were $5.0 million, $5.6 million and $4.7 million,
respectively, for the three years ending from December 31, 1994 to December 31,
1996.

     Capital expenditures of the Partnership during 1997 are expected to be
approximately $8 to 10 million.  (See: "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Capital Resources and
Liquidity").  Additional expansion-related capital expenditures will depend on
future opportunities to expand the Partnership's operation.  The General
Partner intends to finance future expansion capital expenditures primarily
through Partnership borrowings.  Such future expenditures, however, will depend
on many factors beyond the Partnership's control, including, without
limitation, demand for refined petroleum products and terminaling services in
the Partnership's market areas, local, state and federal governmental
regulations, fuel conservation efforts and the availability of financing on
acceptable terms.  No assurance can be given that required capital expenditures
will not exceed anticipated amounts during the year or thereafter or that the
Partnership will have the ability and/or choose to finance such expenditures
through borrowing.

REGULATION

     Interstate Regulation.   The interstate common carrier pipeline operations
of the Partnership are subject to rate regulation by FERC under the Interstate
Commerce Act.  The Interstate Commerce Act provides, among other things, that
to be lawful the rates of common carrier petroleum pipelines must be "just and
reasonable" and not unduly discriminatory.  New and changed rates must be filed
with the FERC, which may investigate their lawfulness on protest or its own
motion.  The FERC may suspend the effectiveness of such rates for up to seven
months.  If the suspension expires before completion of the investigation, the
rates go into effect, but the pipeline can be required to refund to shippers,
with interest, any difference between the level the FERC determines to be
lawful and the filed rates under investigation.  Rates that have become final
and effective may be challenged by complaint to FERC filed by a shipper or on
the FERC's own initiative and reparations may be recovered by the party filing
the complaint for the two year period prior to the complaint, if FERC finds the
rate to be unlawful.

     In general, petroleum product pipeline rates are cost-based.  Such rates
are permitted to generate operating revenues, based on projected volumes, not
greater than the total of the following components:  (i) operating expenses,
(ii) depreciation and amortization, (iii) federal and state income taxes
(determined on a separate company basis and adjusted or "normalized" to avoid
year to year variations in rates due to the effect of timing differences
between book and tax accounting for certain expenses, primarily depreciation)
and (iv) an overall allowed rate of return on the



                                       13

<PAGE>   14



pipeline's "rate base".  Generally, the "rate base" is a measure of the
investment in, or value of, the common carrier assets of a petroleum products
pipeline.

     In 1985, the FERC began issuing a series of opinions ("FERC Opinions")
providing that oil pipeline rates would continue to be cost-based.  The FERC
Opinions required that the rate base should be calculated by the net
depreciated "trended original cost" ("TOC") methodology.  Under the TOC
methodology, after a starting rate base has been determined, a pipeline's rate
base is to be (i) increased by property additions at cost plus an amount equal
to the equity portion of the rate base multiplied or "trended" by an inflation
factor and (ii) decreased by property retirements, depreciation and
amortization of rate base write-ups reflecting inflation.

     The FERC Opinions allow for a rate of return for petroleum products
pipelines determined by adding (i) the product of a rate of return equal to the
nominal cost of debt multiplied by the portion of the rate base that is deemed
to be financed with debt and (ii) the product of a rate of return equal to the
real (i.e., inflation-free) cost of equity multiplied by the portion of the
rate base that is deemed to be financed with equity.  The appropriate rate of
return for a petroleum pipeline is determined on a case-by-case basis, taking
into account cost of capital, competitive factors and business and financial
risks associated with pipeline operations.

     The Interstate Commerce Commission, which regulated oil pipelines until
1978, had formerly determined rate base by using a current valuation
methodology.  The FERC Opinions abandoned the valuation methodology and
required pipelines to establish a transition rate base for the pipeline's
existing plant.  This transition rate base, called the "starting rate base," is
the sum of (i) the net depreciated original cost of the pipeline's property
multiplied by the ratio of debt to total capitalization and (ii) the net
depreciated reproduction portion of the valuation rate base as of 1983,
multiplied by the ratio of equity to total capitalization.  The original cost
of land, rights of way less book depreciation, allowed working capital and
plant less book depreciation that were not included in the 1983 valuation may
be added to the starting rate base.

     The actual capital structure as of June 28, 1985 of either the pipeline or
its parent is typically used to establish the starting rate base.  In general,
the pipeline's structure is used if the pipeline issues long-term debt to
outside investors without any parent guarantee and the parent's structure is
used if the pipeline has no long-term debt, issues long-term debt to its
parent, or its long-term debt is guaranteed by its parent.  In individual
cases, however, FERC may determine that the actual capital structure of the
pipeline or its parent is inappropriate for rate regulation purposes.  The FERC
may then impute to the pipeline the capital structure it deems appropriate to
the pipeline's risk.

     The Partnership has not attempted to depart from cost-based rates.
Instead, it has continued to rely on the traditional, cost-based TOC
methodology.  The TOC methodology has not been subject to judicial review.

     Under Title XVIII of the Energy Policy Act of 1992 (the "EP Act"), rates
that were in effect on October 24, 1991 that were not subject to a protest,
investigation or complaint are deemed to be just and reasonable.  Such rates
are subject to challenge only for limited reasons, relating to (i)
substantially changed circumstances in either the economic circumstances of the
subject pipeline or the nature of the services, (ii) a contractual bar that
prevented the complainant from previously challenging the rates or (iii) a
claim that such rates are unduly discriminatory or preferential.  Any relief
granted pursuant to such challenges may be prospective only.  Because the
Partnership's rates that were in effect on October 24, 1991, were subject to
investigation and protest at that time, its rates were not deemed to be just
and reasonable pursuant to the EP Act.  The Partnership's current rates became
final and effective in April 1994, and the Partnership believes that its
currently effective tariffs are just and reasonable and would withstand
challenge under the FERC's cost-based rate standards.  Because of the
complexity of rate making, however, the lawfulness of any rate is never
assured.

     On October 22, 1993, the FERC issued Order No. 561 implementing the EP
Act.  Order No. 561, among other things, adopted a simplified and generally
acceptable rate making methodology for future oil pipeline rate changes in the
form of indexation.  Indexation, which is also known as price cap regulation,
establishes ceiling prices on oil pipeline rates based on application of a
broad-based measure of inflation in the general economy to existing rates.
Rate increases up to the ceiling level are to be discretionary for the
pipeline, and, for such rate increases, there will be no


                                       14

<PAGE>   15



need to file cost-of-service or supporting data.  Moreover, so long as the
ceiling is not exceeded, a pipeline may make a limitless number of rate change
filings.

     The pipeline rates in effect at December 31, 1994, which are determined to
be just and reasonable, become the "Base Rates" for application of the indexing
mechanism.  This indexing mechanism calculates a ceiling rate.  The pipeline
may increase its rates to this calculated ceiling rate without filing a formal
cost based justification and with limited risk of shipper protests.  Shippers
may still be permitted to protest pipeline rates, even if the rate change does
not exceed the index ceiling, if the shipper can demonstrate that the "increase
is so substantially in excess of the actual cost increase incurred by the
pipeline" that the proposed rate would be unjust and unreasonable.  The index
is cumulative, attaching to the applicable ceiling rate and not to the actual
rate charged.  Thus, a rate that is not increased to the ceiling level in a
given year may still be increased to the ceiling level in the following year.
The pipeline may be required to decrease the current rate if the rate being
charged exceeds the ceiling level.

     The index underlying Order No. 561 is to serve as the principal basis for
the establishment of oil pipeline rate changes in the future.  As explained by
the FERC in Order Nos. 561 and 561-A, however, there may be circumstances where
the indexing mechanism will not apply.  Specifically, the FERC determined that
a pipeline may utilize any one of the following three alternative methodologies
to indexing:  (i) a cost-of-service methodology may be utilized by a pipeline
to justify a change in a rate if a pipeline can demonstrate that its increased
costs are prudently incurred and that there is a substantial divergence between
such increased costs and the rate that would be produced by application of the
index; (ii) a pipeline may file a rate change as part of a settlement when it
secures the agreement of all of its existing shippers; and (iii) a pipeline may
base its rates upon a "light-handed" market-based form of regulation if it is
able to demonstrate a lack of significant market power in the relevant markets.

     The indexing mechanism does not apply to initial rates of a pipeline,
which will still generally be established using the traditional TOC
methodology.  Order No. 561 provides, however, that a pipeline can file an
initial rate based upon the agreement of at least one non-affiliated shipper,
without an accompanying cost-of-service justification for such rate.  Yet, if
this agreed-upon rate is protested by another shipper, the pipeline will be
required to justify the initial rate on a cost-of-service basis.  The initial
rate that is established by the pipeline becomes the pipeline's "Base Rate",
and the indexing mechanism will be applicable to that rate in subsequent years.

     On October 28, 1994, after hearings and public comment period, the FERC
issued Order Nos. 571 and 572, intended as procedural follow-ups to Order No.
561.  In Order No. 571, the FERC (i) articulated cost-of-service and reporting
requirements to be applicable to pipeline initial rates and to situations where
indexing is determined to be inappropriate; (ii) adopted rules for the
establishment of revised depreciation rates; and (iii) revised the information
required to be reported by pipelines in their Form No. 6, "Annual Report for
Oil Pipelines".  Order No. 572 establishes the filing requirements and
procedures that must be followed when a pipeline seeks to charge market-based
rates.

     In the FERC's Lakehead decision issued June 15, 1995, the FERC partially
disallowed Lakehead's inclusion of income taxes in its cost of service.
Specifically, the FERC held that Lakehead was entitled to receive an income tax
allowance with respect to income attributable to its corporate partners, but
was not entitled to receive such an allowance for income attributable to the
Partnership interests held by individuals.  Lakehead's motion for rehearing was
denied by the FERC and Lakehead appealed the decision to the US Court of
Appeals.  Subsequently the case was settled by Lakehead and the appeal was
withdrawn.  In another FERC proceeding that has not yet reached the hearing
stage, involving a different oil pipeline limited partnership, various shippers
have challenged such pipeline's inclusion of an income tax allowance in its
cost of service.  The FERC Staff has also filed testimony that supports the
disallowance of income taxes.  If the FERC were to disallow the income tax
allowance in the cost of service of the Pipelines on the basis set forth in the
Lakehead order, the General Partner believes that the Partnership's ability to
pay the Minimum Quarterly Distribution to the holders of the Senior Preference
Units, Preference Units and Preference B Units would not be impaired; however,
in view of the uncertainties involved in this issue, there can be no assurance
in this regard.

     Intrastate Regulation.  The intrastate operations of the East Pipeline in
Kansas are subject to regulation by the Kansas Corporation Commission, and the
intrastate operations of the West Pipeline in Colorado and Wyoming are subject
to regulation by the Colorado Public Utility commission and the Wyoming Public
Service Commission, respectively.  Like the FERC, the state regulatory
authorities require that shippers be notified of proposed intrastate


                                       15

<PAGE>   16



tariff increases and have an opportunity to protest such increases.  KPOP also
files with such state authorities copies of interstate tariff changes filed
with the FERC.  In addition to challenges to new or proposed rates, challenges
to intrastate rates that have already become effective are permitted by
complaint of an interested person or by independent action of the appropriate
regulatory authority.

ENVIRONMENTAL MATTERS

     General.  The operations of the Partnership are subject to federal, state
and local laws and regulations relating to the protection of the environment.
Although the Partnership believes that its operations are in general compliance
with applicable environmental regulations, risks of substantial costs and
liabilities are inherent in pipeline and terminal operations, and there can be
no assurance that significant costs and liabilities will not be incurred by the
Partnership.  Moreover, it is possible that other developments, such as
increasingly strict environmental laws, regulations and enforcement policies
thereunder, and claims for damages to property or persons resulting from the
operations of the Partnership, past and present, could result in substantial
costs and liabilities to the Partnership.

     Water.  The Oil Pollution Act ("OPA") was enacted in 1990 and amends
provisions of the Federal Water Pollution Control Act of 1972 ("FWPCA") and
other statutes as they pertain to prevention and response to oil spills. The
OPA subjects owners of facilities to strict, joint and potentially unlimited
liability for removal costs and certain other consequences of an oil spill,
where such spill is into navigable waters, along shorelines or in the exclusive
economic zone.  In the event of an oil spill into such waters, substantial
liabilities could be imposed upon the Partnership.  Regulations concerning the
environment are continually being developed and revised in ways that may impose
additional regulatory burdens on the Partnership.

     Contamination resulting from spills or releases of refined petroleum
products are not unusual within the petroleum pipeline industry.  The East
Pipeline has experienced limited groundwater contamination at five terminal
sites (Milford, Iowa, Norfolk and Columbus, Nebraska, and Aberdeen and Yankton,
South Dakota) resulting from spills of refined petroleum products.  Regulatory
authorities have been notified of these findings and remediation projects are
underway or under construction using various remediation techniques.  The
Partnership estimates that $719,000 has been expended to date for remediation
at these five sites and that ongoing remediation expenses at each site will be
less than $5,000 per year for the next several years.  Groundwater
contamination is also known to exist at East Pipeline sites in Augusta, Kansas
and in Potwin, Kansas, but no remediation has been required. Although no
assurances can be made, if remediation is required, the Partnership believes
that the resulting cost would not be material.

     The East Pipeline experienced a spill due to third party damage during the
first quarter of 1991. Remediation of the ground water impacted by this spill
was performed from the second quarter of 1991 through the second quarter of
1996.  During the fourth quarter of 1996, additional site assessment work was
performed to determine the extent of the remaining contamination and to develop
a more effective remediation approach.  Also during the fourth quarter of 1996,
a settlement was reached with the parties previously named in the related
damage suit filed by the Partnership.  Future remediation expenses relative to
this site are not expected to have a material effect upon the results of the
Partnership.

     During 1994, the East Pipeline experienced a seam rupture of its 8"
northbound line in Nebraska in January and another similar rupture on the same
line in April.  As a result of these ruptures, KPOP reduced the maximum
operating pressure on this line to 60% of the Maximum Allowable Operating
Pressure ("MAOP") and, on May 24, 1994, commenced a hydrostatic test to
determine the integrity of over 80 miles of that line.  The test was completed
on the entire 80 miles on May 29, 1994, and the line was authorized to return
to approximately 80% of MAOP pending review by the Department of Transportation
("DOT") of the hydrostatic test results.  On July 29, 1994, the DOT authorized
most of the line to return to the historical MAOP.  Approximately 30 miles of
the line was authorized to return to slightly less than historical MAOP.
Although the Partnership has expended approximately $210,000 to date for
remediation at these rupture sites, the total amount of remediation expenses
that will be required has not yet been determined.  These expenses are not
expected to have a material effect upon the results of the Partnership.


                                       16

<PAGE>   17



     ST has experienced groundwater contamination at its terminal sites at
Baltimore, Maryland, and Alamogordo, New Mexico. Regulatory authorities have
been notified of these findings and cleanup is underway using extraction wells
and air strippers. Groundwater contamination also exists at the ST terminal
site in Stockton, California and in the areas surrounding this site as a result
of the past operations of five of the facilities operating in this area. ST has
entered into an agreement with three of these other companies to allocate
responsibility for the clean up of the contaminated area. Under the current
approach, clean up will not be required, however based on risk assessment, the
site will continue to be monitored and tested. In addition, ST is responsible
for up to two-thirds of the costs associated with existing groundwater
contamination at a formerly owned terminal at Marcy, New York, which also is
being remediated through extraction wells and air strippers. The Partnership
has expended approximately $500,000 through 1996 for remediation at these four
sites and estimates that on-going remediation expenses will aggregate
approximately $200,000 to $300,000 over the next three years.

     Groundwater contamination has been identified at ST terminal sites at
Montgomery, Alabama and Milwaukee, Wisconsin, but no remediation has taken
place.  Shell Oil Company has indemnified ST for any contamination at the
Milwaukee site prior to ST's acquisition of the facility.  Star Enterprises,
the former owner of the Montgomery terminal, has indemnified ST for
contamination at a portion of the Montgomery site where contamination was
identified prior to ST's acquisition of the facility.  A remediation system is
in place to address groundwater contamination at the ST terminal facility in
Augusta, Georgia.  Star Enterprises, the former owner of the Augusta terminal,
has indemnified ST for this contamination and has retained responsibility for
the remediation system.  There is also a possibility that groundwater
contamination may exist at other facilities.  Although no assurance in this
regard can be given, the Partnership believes that such contamination, if
present, could be remedied with extraction wells and air strippers similar to
those that are currently in use and that resulting costs would not be material.

     In 1991, the Environmental Protection Agency (the "EPA") implemented
regulations expanding the definition of hazardous waste.  The Toxicity
Characteristic Leaching Procedure ("TLC") has broadened the definition of
hazardous waste by including 25 constituents that were not previously included
in determining that a waste is hazardous.  Water that comes in contact with
petroleum may fail the TLC procedure and require additional treatment prior to
its disposal.  The Partnership has installed totally enclosed wastewater
treatment systems at all East Pipeline terminal sites to treat such petroleum
contaminated water, especially tank bottom water.

     The EPA has also promulgated regulations that may require the Partnership
to apply for permits to discharge storm water runoff.  Storm water discharge
permits also may be required in certain states in which the Partnership
operates.  Where such requirements are applicable, the Partnership has applied
for such permits and, after the permits are received, will be required to
sample storm water effluent before releasing it.  The Partnership believes that
effluent limitations could be met, if necessary, with minor modifications to
existing facilities and operations.  Although no assurance in this regard can
be given, the Partnership believes that the changes will not have a material
effect on the Partnership's financial condition or results of operations.

     Groundwater remediation efforts are ongoing at the West Pipeline's Dupont
and Fountain, Colorado terminals and at the Cheyenne, Wyoming terminal and Bear
Creek, Wyoming station and will be required at one other West Pipeline
terminal.  Regulatory officials have been consulted in the development of
remediation plans.  In the course of acquisition negotiations for this
terminal, KPOP's regulatory group and its outside environmental consultants
agreed upon the expense and costs of these required remediations.  In
connection with the purchase of the West Pipeline, KPOP agreed to implement the
agreed remediation plans at these specific sites over the succeeding five years
following the acquisition in return for the payment by the seller, Wyco Pipe
Line Company, of $1,312,000 to KPOP to cover the discounted estimated future
costs of these remediations.  In conjunction with the acquisition, the
Partnership accrued $2.1 million for these future remediation expenses.

     The former Steuart terminals have experienced groundwater contamination at
the Piney Point, Maryland, Jacksonville, Florida and each of the Washington,
D.C. facilities.  Foreseeable remediation expenses are estimated not to exceed
$1.8 million.  The Partnership agreed to assume the existing remediation and
the costs thereof up to $1.8 million and the Asset Purchase Agreements
provided, with respect to unknown environmental damages that are


                                       17

<PAGE>   18



discovered after the closing and that were caused by operations conducted by
Steuart prior to the closing, that the Partnership and Steuart will share those
expenses at a ratio of 20% for the Partnership and 80% for Steuart until a
total of $2.5 million has been expended.  Thereafter, such expenses will be the
Partnership's responsibility.  This indemnity will expire in December, 1998.
In conjunction with the acquisition, the Partnership accrued $2.3 million for
potential environmental liabilities arising from the Steuart acquisition.

     Aboveground Storage Tank Acts.  A number of the states in which the
Partnership operates have passed statutes regulating aboveground tanks
containing liquid substances.  Generally, these statutes require that such
tanks include secondary containment systems or that the operators take certain
alternative precautions to ensure that no contamination results from any leaks
or spills from the tanks. Although there is not currently a federal statute
regulating these above ground tanks, there is a possibility that such a law
will be passed within the next couple of years.  The Partnership is in
substantial compliance with all above ground storage tank laws in the states
with such laws.  Although no assurance can be given, the Partnership believes
that the future implementation of above ground storage tank laws by either
additional states or by the federal government will not have a material adverse
effect on the Partnership's financial condition or results of operations.

     Air Emissions.  The operations of the Partnership are subject to the
Federal Clean Air Act and comparable state and local statutes.  The Partnership
believes that the operations of the Pipelines are in substantial compliance
with such statues in all states in which they operate.

     Amendments to the Federal Clean Air Act enacted in late 1990 will require
most industrial operations in the United States to incur future capital
expenditures in order to meet the air emission control standards that have been
and are to be developed and implemented by the EPA and state environmental
agencies.  Pursuant to these Clean Air Act Amendments, those Partnership
facilities that emit volatile organic compounds ("VOC") or nitrogen oxides will
be subject to increasingly stringent regulations, including requirements that
certain sources install maximum or reasonably available control technology.
The EPA is also required to promulgate new regulations governing the emissions
of hazardous air pollutants. Some of the Partnership's facilities are included
within the categories of hazardous air pollutant sources that will be affected
by these regulations.  Additionally, new dockside loading facilities owned or
operated by the Partnership will be subject to the New Source Performance
Standards that were proposed in May 1994.  These regulations will control VOC
emissions from the loading and unloading of tank vessels.  In 1995, ST
completed the installation of a marine vapor collection system and large flare
at its Texas City terminal at a cost of approximately $2.0 million.

     Although the Partnership is in substantial compliance with applicable air
pollution laws, in anticipation of the implementation of stricter air control
regulations, the Partnership is taking actions to substantially reduce its air
emissions. The Partnership plans to install bottom loading and vapor recovery
equipment on the loading racks at selected terminal sites along the East
Pipeline that do not already have such emissions control equipment.  These
modifications will substantially reduce the total air emissions from each of
these facilities.  Having begun in 1993, this project is being phased in over a
period of years.

     Solid Waste.  The Partnership generates non-hazardous solid waste that is
subject to the requirements of the Federal Resource Conservation and Recovery
Act ("RCRA") and comparable state statutes. The EPA is considering the adoption
of stricter disposal standards for non-hazardous wastes.  RCRA also governs the
disposal of hazardous wastes.  At present, the Partnership is not required to
comply with a substantial portion of the RCRA requirements because the
Partnership's operations generate minimal quantities of hazardous wastes.
However, it is anticipated that additional wastes, which could include wastes
currently generated during pipeline operations, will in the future be
designated as "hazardous wastes".  Hazardous wastes are subject to more
rigorous and costly disposal requirements than are non-hazardous wastes.  Such
changes in the regulations may result in additional capital expenditures or
operating expenses by the Partnership.

     At the terminal sites at which groundwater contamination is present, there
is also limited soil contamination as a result of the aforementioned spills.
The Partnership is under no present requirements to remove these contaminated
soils,  but the Partnership may be required to do so in the future.  Soil
contamination also may be present at other Partnership facilities at which
spills or releases have occurred.  Under certain circumstances, the


                                       18
<PAGE>   19



Partnership may be required to clean up such contaminated soils.  Although
these costs should not have a material adverse effect on the Partnership, no
assurance can be given in this regard.

     Superfund.  The Comprehensive Environmental Response, Compensation and
Liability Act ("CERCLA" or "Superfund") imposes liability, without regard to
fault or the legality of the original act, on certain classes of persons that
contributed to the release of a "hazardous substance" into the environment.
These persons include the owner or operator of the site and companies that
disposed or arranged for the disposal of the hazardous substances found at the
site.  CERCLA also authorizes the EPA and, in some instances, third parties to
act in response to threats to the public health or the environment and to seek
to recover from the responsible classes of persons the costs they incur.  In
the course of its ordinary operations, the Partnership may generate waste that
may fall within CERCLA's definition of a "hazardous substance".  The
Partnership may be responsible under CERCLA for all or part of the costs
required to clean up sites at which such wastes have been disposed.

     ST has been named a potentially responsible party for a site located at
Elkton, Maryland, operated by Spectron, Inc. until August 1988.  This site is
presently under the oversight of the EPA and is listed as a federal "Superfund"
site.  A small amount of material handled by Spectron was attributed to ST.
The Partnership believes that ST will be able to settle its potential
obligation in connection with this matter for an aggregate cost of
approximately $10,000.  However, until a final settlement agreement is signed
with the EPA, there is a possibility that the EPA could bring additional claims
against ST.

     Environmental Impact Statement.  The National Environmental Policy Act of
1969 (the "NEPA") applies to certain extensions or additions to a pipeline
system.  Under NEPA, if any project that would significantly affect the quality
of the environment requires a permit or approval from any federal agency, a
detailed environmental impact statement must be prepared. The effect of the
NEPA may be to delay or prevent construction of new facilities or to alter
their location, design or method of construction.

     Indemnification.  KPL has agreed to indemnify the Partnership against
liabilities for damage to the environment resulting from operations of the East
Pipeline prior to October 3, 1989.  Such indemnification does not extend to any
liabilities that arise after such date to the extent such liabilities result
from change in environmental laws or regulations.  Under such indemnity, KPL is
presently liable for the remediation of groundwater contamination resulting
from three spills and the possible groundwater contamination at a pumping and
storage site referred to under "Water" to the standards that are in effect at
the time such remediation operations are concluded.  In addition, ST's former
owner has agreed to indemnify the Partnership against liabilities for damages
to the environment from operations conducted by such former owners prior to
March 2, 1993.  The indemnity, which expires March 1, 1998, is limited in
amount to 60% of any claim exceeding $100,000 until an aggregate amount of $10
million has been paid by ST's former owner.  In addition, with respect to
unknown environmental expenses from operations conducted by Wyco Pipe Line
Company prior to the closing of the Partnership's acquisition of the West
Pipeline, KPOP has agreed to pay the first $150,000 of such expenses, KPOP and
Wyco Pipe Line Company will share, on an equal basis, the next $900,000 of such
expenses and Wyco Pipe Line Company will indemnify KPOP for up to $2,950,000 of
such expenses thereafter.  The indemnity expires in August 1999.  To the extent
that environmental liabilities exceed the amount of such indemnity, KPOP has
affirmatively assumed the excess environmental liabilities.  Also, the Steuart
terminals Asset Purchase Agreements provide, with respect to unknown
environmental damages that are discovered after the closing  of the Steuart
terminals acquisition and that were caused by operations conducted by Steuart
prior to the closing, that the Partnership and Steuart will share expenses
associated with such environmental damages at a ratio of 20% for the
Partnership and 80% for Steuart until a total of $2.5 million has been
expended.  Thereafter, such expenses will be the Partnership's responsibility.
This indemnity will expire in December 1998.

SAFETY REGULATION

     The Pipelines are subject to regulation by the Department of
Transportation under the Hazardous Liquid Pipeline Safety Act of 1979 ("HLPSA")
relating to the design, installation, testing, construction, operation,
replacement and management of their pipeline facilities.  The HLPSA covers
petroleum and petroleum products pipelines and requires any entity that owns or
operates pipeline facilities to comply with such safety regulations and


                                       19

<PAGE>   20



to permit access to and copying of records and to make certain reports and
provide information as required by the Secretary to Transportation.  The
Federal Pipeline Safety Act of 1992 amended the HLPSA to include requirements
of the future use of internal inspection devices.  The Partnership does not
believe that it will be required to make any substantial capital expenditures
to comply with the requirements of HLPSA as so amended.

     The Partnership is subject to the requirements of the Federal Occupational
Safety and Health Act ("OSHA") and comparable state statutes.  The Partnership
believes that it is in general compliance with OSHA requirements, including
general industry standards, record keeping requirements and monitoring of
occupational exposure to benzene.

     The OSHA hazard communication standard, the EPA community right-to-know
regulations under Title III of the Federal Superfund Amendment and
Reauthorization Act, and comparable state statues require the Partnership to
organize information about the hazardous materials used in its operations.
Certain parts of this information must be reported to employees, state and
local governmental authorities, and local citizens upon request.  In general,
the Partnership expects to increase its expenditures during the next decade to
comply with higher industry and regulatory safety standards such as those
described above.  Such expenditures cannot be accurately estimated at this
time, although they are not expected to have a material adverse impact on the
Partnership.

EMPLOYEES

     The Partnership has no employees.  The business of the Partnership is
conducted by the General Partner, KPL, which at December 31, 1996, employed 426
persons, 201 of whom were salaried and 225 were hourly rate employees.
Approximately 167 of the persons employed by KPL were subject to representation
by unions for collective bargaining purposes; however, only 55 persons employed
by the terminal division of KPL were represented by the Oil, Chemical and
Atomic Workers International Union AFL-CIO ("OCAW").  The terminal division has
an agreement with OCAW for 38 of the above employees, which is in effect
through June 28, 1999.  The agreement is subject to automatic renewal for
successive one-year periods unless one of the parties serves written notice to
terminate such agreement in a timely manner.  The terminal division is
currently bargaining in good faith with OCAW to reach a collective bargaining
agreement for the remaining 17 of such 55 employees.

ITEM 2. PROPERTIES

     Descriptions of properties owned or utilized by the Partnership are
contained in Item 1 of this report and such descriptions are hereby
incorporated by reference into this Item 2. Under the captioned "Leases" in
notes to the Partnership's financial statements included in Item 8 herein
below, additional information is presented concerning obligations for lease and
rental commitments. Said additional information is hereby incorporated by
reference into this Item 2.

ITEM 3. LEGAL PROCEEDINGS

     The Partnership is a party to several lawsuits arising in the ordinary
course of business.  Subject to certain deductibles and self-insurance
retentions, substantially all the claims made in these lawsuits are covered by
insurance policies.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     The Partnership did not hold a meeting of unitholders or otherwise submit
any matter to a vote of security holders in the fourth quarter of 1996.


                                       20

<PAGE>   21

                                    PART II


ITEM 5. MARKET FOR THE REGISTRANT'S SENIOR PREFERENCE UNITS AND PREFERENCE
        UNITS AND RELATED UNITHOLDER MATTERS

     The Partnership's senior preference limited partner interests ("Senior
Preference Units") and Preference Units are listed and traded on the New York
Stock Exchange.  At March 10, 1997, there were approximately 1,000 Senior
Preference Unitholders of record and approximately 200 Preference Unitholders
of record.  Set forth below are prices and cash distributions for Senior
Preference Units and Preference Units, respectively, on the New York Stock
Exchange.


<TABLE>
<CAPTION>
                             SENIOR PREFERENCE         PREFERENCE           CASH
                                UNIT PRICES           UNIT PRICES       DISTRIBUTIONS
YEAR                          HIGH       LOW        HIGH        LOW        DECLARED
----                         ------     ------     ------      ------   -------------
<S>                          <C>        <C>        <C>         <C>            <C>
1995:
  First Quarter              24 3/4     20 5/8                                .55
  Second Quarter             24 1/2     20 3/4                                .55
  Third Quarter              24 3/4     22 3/8     22 5/8(a)   22             .55
  Fourth Quarter             25         23 1/8     22 1/2      21 5/8         .55
1996:
  First Quarter              26 1/2     23 7/8     24 5/8      22 1/4         .55
  Second Quarter             26 5/8     24 1/4     24 5/8      23 1/8         .55
  Third Quarter              26 5/8     24 3/4     25 7/8      22 7/8         .60
  Fourth Quarter             30         25 5/8     28 1/8      25             .60

1997:
  First Quarter              31 1/4     28 5/8     28 5/8      26 1/2
   (through March 10, 1997)
</TABLE>


(a)  Preference Units commenced trading on September 20, 1995.

     The Partnership has paid the Minimum Quarterly Distribution on each
outstanding Senior Preference Unit for each quarter since the Partnership's
inception. The Partnership has also paid the Minimum Quarterly Distribution on
Preference Units with respect to all quarters since inception of the
Partnership, except for distributions in the second, third and fourth quarters
of 1991 totaling $9,323,000 which have since been satisfied and no arrearages
remain as of December 31, 1996. Prior to 1994, no distributions were paid on
the outstanding Common Units, which are not entitled to arrearages in the
payment of the Minimum Quarterly. Distributions paid on the Common Units were
$1,738,000; $4,582,000 and $7,110,000 for 1994, 1995 and 1996, respectively.

     Under the terms of its financing agreements, the Partnership is prohibited
from declaring or paying any distribution if a default exists thereunder.


                                       21

<PAGE>   22



ITEM 6. SUMMARY HISTORICAL FINANCIAL AND OPERATING DATA

     The following table sets forth, for the periods and at the dates
indicated, selected historical financial and operating data for Kaneb Pipe Line
Partners, L.P. and Subsidiaries (the "Partnership").  The data in the table (in
thousands, except per unit amounts) is derived from the historical financial
statements of the Partnership and should be read in conjunction with the
Partnership's audited financial statements.  See also "Management's Discussion
and Analysis of Financial Condition and Results of Operations."


<TABLE>
<CAPTION>
                                                     Year Ended December 31,
                                   -------------------------------------------------------------
                                      1992       1993(a)        1994       1995(b)       1996
                                   ---------    ---------    ---------    ---------    ---------
<S>                                <C>          <C>          <C>          <C>          <C>      
INCOME STATEMENT DATA:
Revenues .......................   $  42,179    $  69,235    $  78,745    $  96,928    $ 117,554
                                   ---------    ---------    ---------    ---------    ---------

Operating costs ................      14,507       29,012       33,586       40,617       49,925
Depreciation and amortization ..       4,124        6,135        7,257        8,261       10,981
General and administrative .....       2,752        4,673        4,924        5,472        5,259
                                   ---------    ---------    ---------    ---------    ---------

   Total costs and expenses ....      21,383       39,820       45,767       54,350       66,165
                                   ---------    ---------    ---------    ---------    ---------

Operating income ...............      20,796       29,415       32,978       42,578       51,389
Interest and other income ......       1,721        1,331        1,299          894          776
Interest expense ...............      (2,338)      (3,376)      (3,706)      (6,437)     (11,033)
Minority interest ..............        (200)        (266)        (295)        (360)        (403)
                                   ---------    ---------    ---------    ---------    ---------
Income before income taxes .....      19,979       27,104       30,276       36,675       40,729
Income taxes (c) ...............        --           (450)        (818)        (627)        (822)
                                   ---------    ---------    ---------    ---------    ---------

Net income .....................   $  19,979    $  26,654    $  29,458    $  36,048    $  39,907
                                   =========    =========    =========    =========    =========

Allocation of net income(d) per:
   Senior Preference Unit ......   $    2.20    $    2.20    $    2.20    $    2.20    $    2.46
                                   =========    =========    =========    =========    =========
   Preference Unit .............   $    2.20    $    2.20    $    2.20    $    2.20    $    2.46
                                   =========    =========    =========    =========    =========
   Preference Unit arrearages ..   $     .45    $    1.20    $    --      $     --     $    --
                                   =========    =========    =========    =========    =========

Cash Distributions declared per:
   Senior Preference Unit ......   $    2.20    $    2.20    $    2.20    $    2.20    $    2.30
                                   =========    =========    =========    =========    =========
   Preference Unit .............   $    2.20    $    2.20    $    2.20    $    2.20    $    2.30
                                   =========    =========    =========    =========    =========
   Preference Unit arrearages ..   $     .45    $    1.20    $    --      $     --     $    --
                                   =========    =========    =========    =========    =========

BALANCE SHEET DATA (AT
   PERIOD END):
Property and equipment, net ....   $  66,956    $ 133,436    $ 145,646    $ 246,471    $ 249,733
Total assets ...................      86,409      162,407      163,105      267,787      274,765
Long-term debt .................      20,864       41,814       43,265      136,489      139,453
Partners' capital ..............      55,657      100,598       99,754      100,748      103,340
</TABLE>


(a)  Includes the operations of ST since its acquisition on March 2, 1993.
(b)  Includes the operations of the West Pipeline since its acquisition in
     February 1995 and the operations of Steuart since its acquisition in
     December 1995.
(c)  Subsequent to the acquisition of ST in March 1993, certain operations are
     conducted in taxable entities.
(d)  Net income is allocated to the limited partnership units in an amount
     equal to the cash distributions declared for each reporting period and any
     remaining income or loss is allocated to the class of units that did not
     receive the same amount of cash distributions per unit (if any). If the
     same cash distributions per unit are declared to all classes of units,
     income is allocated pro rata based on the aggregate amount of
     distributions declared.



                                       22

<PAGE>   23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

     This discussion should be read in conjunction with the consolidated
financial statements of Kaneb Pipe Line Partners, L.P. and notes thereto and
the summary historical and pro forma financial and operating data included
elsewhere in this report.

GENERAL

     In September 1989, Kaneb Pipe Line Company ("KPL"), a wholly-owned
subsidiary of Kaneb Services, Inc. ("Kaneb"), formed the Partnership to own and
operate its refined petroleum products pipeline business.  The Partnership
operates through KPOP, a limited partnership in which the Partnership holds a
99% interest as limited partner and KPL owns a 1% interest as general partner
in both the Partnership and KPOP.  The Partnership is engaged through operating
subsidiaries in the refined petroleum products pipeline business and, since
1993, terminaling and storage of petroleum products and specialty liquids.

     The Partnership's pipeline business consists primarily of the
transportation through the East Pipeline and the West Pipeline, as common
carriers, of refined petroleum products.  The Partnership acquired the West
Pipeline in February 1995 from Wyco Pipe Line Company, a company jointly owned
by GATX Terminals Corporation and Amoco Pipeline Company, for $27.1 million
plus transaction costs and the assumption of certain environmental liabilities.
The acquisition was financed by the issuance of $27 million of first mortgage
notes to a group of insurance companies due February 24, 2002, which bear
interest at the rate of 8.37% per annum.  The East Pipeline and the West
Pipeline are collectively referred to as the "Pipelines."  The Pipelines
primarily transport gasoline, diesel oil, fuel oil and propane.  The products
are transported from refineries connected to the Pipeline, directly or through
other pipelines, to agricultural users, railroads and wholesale customers in
the states in which the Pipelines are located and in portions of other states.
Substantially all of the Pipelines' operations constitute common carrier
operations that are subject to federal or state tariff regulations.  The
Partnership has not engaged, nor does it currently  intend to engage, in the
merchant function of buying and selling refined petroleum products.

     The Partnership's business of terminaling petroleum products and specialty
liquids is conducted under the name ST Services ("ST"). The Partnership is the
third largest independent terminaling company in the United States.  With the
acquisition of Steuart (see below), ST operates 31 facilities in 16 states and
the District of Columbia with an aggregate tankage capacity of approximately
17.2 million barrels.  The Texas City terminal is a deep-water facility
primarily serving the Gulf Coast petrochemical industry.  The Westwego
terminal, purchased in June 1994 and located on the West bank of the
Mississippi River across from New Orleans, handles molasses, animal and
vegetable oil and fats, fertilizer, latex and caustic solutions.  The Baltimore
terminal is the largest independent terminal facility in the Baltimore area and
handles asphalt, fructose, latex, caustic solutions and other liquids.

     ST acquired the liquids terminaling assets of Steuart Petroleum Company
and certain of its affiliates (collectively, "Steuart") in December 1995 for
$68 million plus transaction costs and the assumption of certain environmental
liabilities.  The acquisition was initially financed with a $68 million bridge
loan from a bank. The Partnership refinanced this bridge loan in June 1996 with
a series of first mortgage notes (the "Steuart Notes") to a group of insurance
companies bearing interest at rates ranging from 7.08% to 7.98% and maturing in
varying amounts in June 2001, 2003, 2006 and 2016.  The Steuart terminaling
assets consist of seven petroleum product terminal facilities located in the
District of Columbia, Florida, Georgia, Maryland and Virginia and the pipeline
and terminaling facilities serving Andrews Air Force Base in Maryland.  The
Piney Point, Maryland terminal is the closest petroleum storage facility to
Washington D.C. which has access to deep water.  The Jacksonville terminal has
28 tanks with approximately 2.1 million barrels of aggregate storage capacity,
which are currently used to store petroleum products.  The remainder of ST's
terminals primarily handle petroleum products.

     The Partnership acquired ST in March 1993 for approximately $65 million
(including $2 million in acquisition costs).  In connection with the
acquisition, the Partnership borrowed $65 million from a group of banks.  In
April 1993, the Partnership completed a public offering of 2.25 million Senior
Preference Units at $25.25 per unit.  The


                                       23

<PAGE>   24



bank loan was partially repaid with $50.8 million of the proceeds from the
offering, and the balance was refinanced with first mortgage notes in December
1994.  The  Partnership continually evaluates other potential acquisitions.

PIPELINE OPERATIONS

<TABLE>
<CAPTION>
                                                      Year Ended December 31,
                                                  ------------------------------
                                                    1994       1995       1996
                                                  --------   --------   --------
<S>                                               <C>        <C>        <C>     
  Revenues ....................................   $ 46,117   $ 60,192   $ 63,441
  Operating costs .............................     17,777     22,564     23,692
  Depreciation and amortization ...............      4,276      4,843      4,817
  General and administrative ..................      2,908      3,038      2,711
                                                  --------   --------   --------
  Operating income ............................   $ 21,156   $ 29,747   $ 32,221
                                                  ========   ========   ========
</TABLE>


     The Pipelines' revenues are based on volumes shipped and the distances
over which such volumes are transported.  Revenues increased $3.2 million and
$14.1 million in 1996 and 1995, respectively.  The increases in both years are
primarily due to the acquisition of the West Pipeline in February 1995.
Because tariff rates are regulated by the FERC, the Pipelines compete primarily
on the basis of quality of service, including delivering products at convenient
locations on a timely basis to meet the needs of its customers.  Barrel miles
totaled 16.7 billion in 1996 compared to 16.6 billion in 1995.  Barrel miles in
1995 increased from 14.5 billion barrel miles in 1994, primarily due to the
acquisition of the West Pipeline.

     Operating costs which include fuel and power costs, materials and
supplies, maintenance and repair costs, salaries, wages and employee benefits,
and property and other taxes, increased $1.1 million in 1996 and $4.8 million
in 1995.  The 1996 increase is primarily due to higher materials and supplies,
including additives and outside services, and the 1995 increase is primarily a
result of the West Pipeline acquisition.  The 1995 increase in depreciation and
amortization is a direct result of the February 1995 acquisition of the West
Pipeline.  General and administrative costs include managerial, accounting and
administrative personnel costs, office rental and expense, legal and
professional costs and other non-operating costs.  The decrease in 1996 from
1995 was primarily due to lower legal and professional and other non-operating
costs.

TERMINALING OPERATIONS

<TABLE>
<CAPTION>
                                                     Year Ended December 31,
                                                  ------------------------------
                                                    1994       1995       1996
                                                  --------   --------   --------
<S>                                               <C>        <C>        <C>     
  Revenues ....................................   $ 32,628   $ 36,736   $ 54,113
  Operating costs .............................     15,809     18,053     26,233
  Depreciation and amortization ...............      2,981      3,418      6,164
  General and administrative ..................      2,016      2,434      2,548
                                                  --------   --------   --------
  Operating income ............................   $ 11,822   $ 12,831   $ 19,168
                                                  ========   ========   ========
</TABLE>


     The increases in revenues are attributable to acquisitions and increases
in prices charged for storage and tankage volumes utilized. Revenues increased
47% in 1996 primarily from the acquisition of the Steuart Petroleum terminals
in December 1995 and 13% in 1995.  Average annual tankage utilized increased
5.2 million barrels in 1996 to 11.9 million barrels compared to 6.7 million
barrels in 1995 primarily as a result of the Steuart terminals acquired and
increased 600,000 barrels in 1995 over 1994 also primarily as a result of other
terminal acquisitions.  Average annual revenues per barrel of tankage utilized
was $4.55 per barrel in 1996 compared to $5.46 per barrel in 1995.  The
decrease in per barrel averages is due to the large proportionate volumes of
petroleum products being stored at the Steuart terminals with lower rates per
barrel than specialty chemicals with higher rates per barrel that are stored at
other terminals.  Average annual revenues per barrel of tankage utilized
increased $0.13 per barrel in 1995 over 1994.

     Total tankage capacity (17.2 million barrels at December 31, 1996) has
been, and is expected to remain, adequate to meet existing customer storage
requirements. Customers consider factors such as location, access to cost
effective transportation and quality of service in addition to pricing when
selecting terminal storage. Operating costs increased $8.2 million and $2.2
million and depreciation and amortization increased $2.7 million and $.4
million in 1996 and 1995, respectively, primarily as a result of terminal
acquisitions.


                                       24

<PAGE>   25

LIQUIDITY AND CAPITAL RESOURCES

     The ratio of current assets to current liabilities was 1.02 to 1 at
December 31, 1996 and 0.9 to 1 at December 31, 1995.  Cash provided by
operating activities was $49.2 million, $44.5 million and $37.9 million for the
years 1996, 1995 and 1994 respectively.  The increase in cash flow from
operating activities in 1995 was primarily a result of the West Pipeline and
terminal acquisitions while the increase in cash flow from operating activities
in 1996 was primarily a result of the acquisition of the Steuart terminaling
assets.

     Capital expenditures, excluding expansion capital expenditures, were $7.1
million, $9.0 million and $7.2 million for 1996, 1995 and 1994, respectively.
During all periods, adequate pipeline capacity existed to accommodate volume
growth, and the expenditures required for environmental and safety improvements
were not, and are not expected in the future to be, material.  Environmental
damages caused by sudden and accidental occurrences are included under the
Partnership's insurance coverages. Capital expenditures of the Partnership
during 1997 are expected to be approximately $8 to $10 million.

     The Partnership makes distributions of 100% of its Available Cash to
Unitholders and the General Partner.  Available Cash consists generally of all
the cash receipts less all cash disbursements and reserves.  Distributions of
$2.30 per unit were declared to Senior Preference Unitholders and Preference
Unitholders in 1996 and $2.20 per unit was declared in 1995 and 1994. During
1996, 1995 and 1994, the Partnership declared distributions of $7.3 million
($2.30 per unit); $6.3 million ($2.00 per unit); and $1.7 million ($0.55 per
unit), respectively, to the holders of Common Units.

     The Partnership expects to fund future cash distributions and maintenance
capital expenditures with existing cash and cash flows from operating
activities.  Expansionary capital expenditures are expected to be funded
through additional Partnership borrowings.

     In 1994, a subsidiary of the Partnership issued $33 million of first
mortgage notes (the "Series B Notes") to a group of insurance companies.
Proceeds from these notes were used to refinance existing debt of the
Partnership that was incurred in connection with the ST acquisition in 1993 and
the terminal acquisitions in 1994.  The notes bear interest at the rate of
8.05% per annum and are due on December 22, 2001.  In 1994, the Partnership
entered into the Credit Agreement with two banks that provides a $15 million
revolving credit facility for working capital and other partnership purposes.
Borrowings under the Credit Agreement bear interest at variable rates and are
due and payable in November 1997.  The Credit Agreement has a commitment fee of
0.2% per annum of the unused credit facility.  $5 million was drawn under this
credit facility at December 31, 1996.

     The Partnership acquired the West Pipeline in February 1995 from Wyco Pipe
Line Company, a company jointly owned by GATX Terminals Corporation and Amoco
Pipeline Company, for $27.1 million. The acquisition was financed by the
issuance of $27 million of first mortgage notes (the "Series A Notes") due
February 24, 2002, which bear interest at the rate of 8.37% per annum. The
Series A and B Notes and credit facility are secured by a mortgage on the East
Pipeline.

     The acquisition of the Steuart terminaling assets was initially financed
by a $68 million bank bridge loan. The Partnership refinanced this bridge loan
in June 1996 with a series of first mortgage notes (the "Steuart Notes")
bearing interest at rates ranging from 7.08% to 7.98% and maturing in varying
amounts in June 2001, 2003, 2006 and 2016.  The Steuart Notes are secured, pari
passu with the Series A and B Notes and credit facility, by a mortgage on the
East Pipeline.

     In the FERC's Lakehead decision issued June 15, 1995, the FERC partially
disallowed Lakehead's inclusion of income taxes in its cost of service.
Specifically, the FERC held that Lakehead was entitled to receive an income tax
allowance with respect to income attributable to its corporate partners, but
was not entitled to receive such an allowance for income attributable to the
partnership interests held by individuals.  Lakehead's motion for rehearing was
denied by the FERC and Lakehead appealed the decision to the U. S. Court of
Appeals.  Subsequently, the case was settled by Lakehead and the appeal
withdrawn.  In another FERC proceeding that has not yet reached the hearing
stage, involving


                                       25

<PAGE>   26



a different oil pipeline limited partnership, various shippers have challenged
such pipeline's inclusion of an income tax allowance in its cost of service.
The FERC Staff has also filed testimony that supports the disallowance of
income taxes.  If the FERC were to disallow the income tax allowance in the
cost of service of the Pipelines on the basis set forth in the Lakehead order,
the General Partner believes that the Partnership's ability to pay the Minimum
Quarterly Distribution to the holders of the Senior Preference Units,
Preference Units and Preference B Units would not be impaired; however, in view
of the uncertainties involved in this issue, there can be no assurance in this
regard.

NEW ACCOUNTING PRONOUNCEMENT

     In March 1995, The Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of
(SFAS 121).  SFAS 121 is effective for financial statements for fiscal years
beginning after December 15, 1995 and requires the write-down to market of
certain long-lived assets.  The Partnership adopted SFAS 121 in the first
quarter of 1996 and such adoption did not have a material effect on the
Partnership's financial position or results of operations.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The financial statements and supplementary data of the Partnership begin
on page F-1 of this report.  Such information is hereby incorporated by
reference into this item 8.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE.

        Not applicable.


                                       26

<PAGE>   27
                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     The Partnership is a limited partnership and has no directors.  The
Partnership is managed by the Company as general partner.  Set forth below is
certain information concerning the directors and executive officers of the
Company.  All directors of the Company are elected annually by Kaneb, as its
sole stockholder.  All officers serve at the discretion of the Board of
Directors of the Company.


<TABLE>
<CAPTION>
                                                              UNITS BENEFICIALLY OWNED AT MARCH 10, 1997(L)
                                          YEARS OF SERVICE ----------------------------------------------------
                          POSITION WITH       WITH THE       SENIOR    % OF  PREFERENCE  % OF   COMMON    % OF
       NAME          AGE   THE COMPANY        COMPANY      PREFERENCE  CLASS    UNITS    CLASS  UNITS     CLASS
---------------------------------------------------------------------------------------------------------------
<S>                  <C> <C>                    <C>          <C>         <C>    <C>        <C>  <C>       <C> 
Edward D. Doherty    61  Chairman of            7(a)         8,326       *      1,200      *    75,000    2.4%
                          the Board and
                          Chief Executive
                          Officer
Leon E. Hutchens     62  President             37(b)           148       *        -0-      *       -0-      *
Howard C. Wadsworth  52  Vice President         3(c)           -0-       *        -0-      *       -0-      *
                          Treasurer and
                          Secretary
Jimmy L. Harrison    43  Controller             5(d)           -0-       *        -0-      *       -0-      *
John R. Barnes       52  Director              10(e)        76,600       1%    60,500      1%   79,000    2.5%
Charles R. Cox       54  Director               2(f)           -0-       *        -0-      *       -0-      *
Sangwoo Ahn          58  Director               8(g)        35,000       *        -0-      *       -0-      *
Frank M. Burke, Jr   57  Director               -(h)           -0-       *        -0-      *       -0-      *
James R. Whatley     70  Director               8(i)        22,400       *        -0-      *       -0-      *
Ralph A. Rehm        51  Director               6(j)           -0-       *        -0-      *       -0-      *
Murray A. Biles      66  Director              43(k)           500       *        -0-      *       -0-      *
</TABLE>

--------------
*Less than one percent

(a)  Mr. Doherty, Chairman of the Board of the Company since September 1989,
     is also Senior Vice President of Kaneb.
(b)  Mr. Hutchens assumed his current position in January 1994, having been
     with KPL since January 1960.  Mr. Hutchens had been Vice President since
     January 1981.  Mr. Hutchens was Manager of Product Movement from July 1976
     to January 1981.
(c)  Mr. Wadsworth also serves as Vice President, Treasurer and Secretary for
     Kaneb.  Mr. Wadsworth joined Kaneb in October, 1990.
(d)  Mr. Harrison assumed his present position in November, 1992, prior to
     which he served in a variety of financial positions including Assistant
     Secretary and Treasurer with ARCO Pipe Line Company for approximately 19
     years.
(e)  Mr. Barnes, a director of the Company, is also Chairman of the Board,
     President and Chief Executive Officer of Kaneb.
(f)  Mr. Cox, a director of the Company since September 1995, is also a
     director of Kaneb.  Mr. Cox has held senior executive level positions for
     more than the past five years of his twenty-seven year career with Fluor
     Daniel, Inc.
(g)  Mr. Ahn, a director of the Company since July 1989, is also a director of
     Kaneb. Mr. Ahn has been a partner of Morgan Lewis Githens & Ahn, L.P., an
     investment banking firm, since 1982 and currently serves as a director of
     Gradall Industries, Inc., ITI Technologies, Inc., PAR Technology
     Corporation, Quaker Fabric Corporation, and Stuart Entertainment, Inc.
(h)  Mr. Burke, elected as a director of the Company in January 1997, is also
     a director of Kaneb. Mr. Burke has been Chairman and Managing General
     Partner of Burke, Mayborn Company, Ltd., a private investment company, for
     more than the past five years.  He was previously associated with Peat,
     Marwick, Mitchell & Co. (now KPMG Peat Marwick, LLP), an international
     firm of certified public accountants, for twenty-four years.


                                       27
<PAGE>   28



(i)  Mr. Whatley, a director of the Company since July 1989, is also a director
     of Kaneb. In addition to serving as Chairman of the Board of Directors of
     Kaneb from February 1981 until April 1989, Mr. Whatley was elected and
     served in the additional offices of President and Chief Executive Officer
     of Kaneb from June until October 1986.
(j)  Mr. Ralph Rehm, who is also a director of Kaneb, is President of
     NorthLake Consulting Company, which provides financial consulting
     services.
(k)  Mr. Biles joined the Company in November 1953 and served as President
     from January 1985 until his retirement at the close of 1993.
(l)  Units of the Partnership listed are those which are owned by the person
     indicated, his spouse or children living at home. None of the directors of
     the Company owns more than two percent of the outstanding Senior
     Preference Units or Preference Units, respectively, of the Partnership.
     Each director had sole power with respect to all or substantially all of
     the Units attributed to him.

AUDIT COMMITTEE

     Messrs. Sangwoo Ahn and, effective February 20, 1997, Frank M. Burke, Jr.
serve as the members of the Audit Committee of the Company.  Such Committee
will, on an annual basis, or more frequently as such Committee may determine to
be appropriate, review policies and practices of the Company and the
Partnership and deal with various matters as to which conflicts of interest may
arise.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

     The Company's Board of Directors does not have a compensation committee 
or any other committee that performs the equivalent functions.  During the
fiscal year ended December 31, 1996, none of the Company's officers or
employees participated in the deliberations of the Company's Board of Directors
concerning executive officer compensation.


                                       28

<PAGE>   29
ITEM 11. EXECUTIVE COMPENSATION

     The Partnership has no executive officers, but is obligated to reimburse
the Company for compensation paid to the Company's executive officers in
connection with their operation of the Partnership's business.

     The following table sets forth information with respect to the aggregate
compensation paid or accrued by the Company during the fiscal years 1996, 1995
and 1994, to the Chief Executive Officer and each of the most highly
compensated executive officers of the Company whose aggregate cash compensation
exceeded $100,000.

                           SUMMARY COMPENSATION TABLE


<TABLE>
<CAPTION>
                                      Annual Compensation                     
 Name and Principal                ------------------------         All Other
     Position          Year        Salary          Bonus(a)      Compensation(b)
--------------------   ----        ------          --------      ---------------
<S>                    <C>        <C>              <C>                <C>   
Edward D. Doherty(c)   1996       $200,333(d)      $ 93,040           $6,832
 Chairman of the       1995        190,833          133,100            6,096
 Board and Chief       1994        180,417           40,000            6,833
 Executive Officer

Leon E. Hutchens       1996        173,700           15,000            7,051
 President             1995        164,644           30,000            7,278
                       1994        158,403            5,000            6,465

Jimmy L. Harrison      1996        105,532            4,000            3,775
 Controller            1995        100,670            8,500            5,450
</TABLE>

(a)  Amounts earned in year shown and paid the following year.
(b)  Represents the Company's contributions to Kaneb's Savings Investment Plan
     (a 401(k) plan) and the imputed value of Company-paid group term life
     insurance exceeding $50,000.
(c)  The Compensation for this individual is paid by Kaneb which is reimbursed
     for all or substantially all of such compensation by the Company.
(d)  Includes deferred compensation of $14,901.

Retirement Plan

     Effective April 1, 1991, Kaneb established the Savings Investment Plan, a
defined contribution 401(k) plan, that permits all full-time employees of the
Company who have completed one year of service to contribute 2% to 12% of base
compensation, on a pre-tax basis, into participant accounts.  In addition to
mandatory contribution equal to 2% of base compensation per year for each plan
participant, the Company makes matching contributions from 25% to 50% of up to
the first 6% of base pay contributed by a plan participant.  Employee
contributions, together with earnings thereon, are not subject to forfeiture.
That portion of a participant's account balance attributable to Company
contributions, together with earnings thereon, is vested over a five year
period at 20% per year.  Participants are credited with their prior years of
service for vesting purposes, however, no amounts are accrued for the accounts
of participants, including the Company's executive officers, for years of
service previous to the plan commencement date.  Participants may direct the
investment of their contributions into a variety of investments, including
Kaneb common stock.  Plan assets are held and distributed pursuant to a trust
arrangement.  Because levels of future compensation, participant contributions
and investment yields cannot be reliably predicted over the span of time
contemplated by a plan of this nature, it is impractical to estimate the annual
benefits payable at retirement to the individuals listed in the Summary Cash
Compensation Table above.

     Director's Fees.  During 1996, each member of the Company's Board of
Directors who was not also an employee of the Company or Kaneb was paid an
annual retainer of $4,000 in lieu of all attendance fees.


                                       29

<PAGE>   30



ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     At March 10, 1997, the Company owned a combined 2% General Partner
interest in the Partnership and the Operating Partnership, and owned Preference
Units, Preference B Units and Common Units representing an aggregate limited
partner interest of approximately 31%.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The Company is entitled to certain reimbursements under the Partnership
Agreement. For additional information regarding the nature and amount of such
reimbursements, see Notes 5 and 6 to the Partnership's financial statements.

                                    PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

  (a) (1) FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                                       Page
                                                                                       ----
<S>                                                                                     <C>
     Set forth below is a list of financial statements appearing in this report.


     Kaneb Pipe Line Partners, L.P. and Subsidiaries Financial Statements:
       Consolidated Statements of Income - Three Years Ended December 31, 1996 .......  F-1
       Consolidated Balance Sheets - December 31, 1996 and 1995 ......................  F-2
       Consolidated Statements of Cash Flows - Three Years Ended December 31, 1996 ...  F-3
       Consolidated Statements of Partners' Capital
         Three Years ended December 31, 1996 .........................................  F-4
     Notes to Consolidated Financial Statements ......................................  F-5
     Report of Independent Accountants ...............................................  F-13
</TABLE>


  (a) (2) FINANCIAL STATEMENT SCHEDULES

          All schedules for which provision is made in the applicable
          accounting regulation of the Securities and Exchange Commission are
          not required under the related instructions or are inapplicable, and
          therefore have been omitted.

  (a) (3) LIST OF EXHIBITS

3.1     Amended and Restated Agreement of Limited Partnership dated September 
        27, 1989, filed as Appendix A to the Registrant's Prospectus, dated
        September 25, 1989, in connection with the Registrant's Registration
        Statement on Form S-1 (S.E.C. File No. 33-30330) which exhibit is
        hereby incorporated by reference.

10.1    ST Agreement and Plan of Merger date December 21, 1992 by and between 
        Grace Energy Corporation, Support Terminal Services, Inc., Standard
        Transpipe Corp., and Kaneb Pipe Line Operating Partnership, NSTS, Inc.
        and NSTI, Inc. as amended by Amendment of STS Merger Agreement dated
        March 2, 1993. Filed as Exhibit 10.1 of the exhibits to Registrant's
        current Report on Form 8-K, dated March 16, 1993, which exhibit is
        hereby incorporated by reference.

10.2    Restated Credit Agreement between Kaneb Operating Partnership, L.P. 
        ("KPOP"), Texas Commerce Bank, N.A., ("TCB"), and certain other
        Lenders, dated December 22, 1994, filed as Exhibit 10.13 of the
        exhibits to the Registrant's 1994 Form 10-K, which exhibit is hereby
        incorporated by reference.

10.3    Pledge and Security Agreement between Kaneb Pipe Line Company ("KPL") 
        and TCB, dated October 11, 1993, filed as Exhibit 10.3 of the exhibits
        to the Registrant's 1993 Form 10-K, which exhibit is hereby
        incorporated by reference.


                                       30

<PAGE>   31



     10.4    Note Purchase Agreement, dated December 22, 1994 (the "1994 Note
             Purchase Agreement"), filed as Exhibit 10.2 of the exhibits to
             Registrant's Current Report on Form 8-K, dated March 13, 1995 (the
             "March 1995 Form 8-K"), which exhibit is hereby incorporated by
             reference.

     10.5    Note Purchase Agreements, dated June 27, 1996, filed herewith.

     10.6    Agreement for Sale and Purchase of Assets between Wyco Pipe Line
             Company and KPOP, dated February 19, 1995, filed as Exhibit 10.1
             of the exhibits to the Registrant's Registrant's report on Form
             8-K filed with the Securities and Exchange Commission on March 13,
             1995, and said exhibit is hereby incorporated by reference.

     10.7    Asset Purchase Agreements between and among Steuart Petroleum
             Company, SPC Terminals, Inc., Piney Point Industries, Inc.,
             Steuart Investment Company, Support Terminals Operating
             Partnership, L.P. and KPOP, as amended, dated August 27, 1995.
             Said documents are on file as Exhibits 10.1, 10.2, 10.3, and 10.4
             of the exhibits to Registrant's current report on Form 8-K dated
             January 3, 1996, and said exhibits are hereby incorporated by
             reference.

     21      List of Subsidiaries, filed herewith.

     24.1    Powers of Attorney, not applicable.

     27      Financial Data Schedule, filed herewith.


     (b) REPORTS ON FORM 8-K - NONE.


                                       31

<PAGE>   32
                KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES
                       CONSOLIDATED STATEMENTS OF INCOME


<TABLE>
<CAPTION>
                                                        Year Ended December 31,
                                             --------------------------------------------
                                                 1996            1995            1994 
                                             ------------    ------------    ------------
<S>                                          <C>             <C>             <C>         
Revenues .................................   $117,554,000    $ 96,928,000    $ 78,745,000
                                             ------------    ------------    ------------

Costs and expenses:
   Operating costs .......................     49,925,000      40,617,000      33,586,000
   Depreciation and amortization .........     10,981,000       8,261,000       7,257,000
   General and administrative ............      5,259,000       5,472,000       4,924,000
                                             ------------    ------------    ------------

      Total costs and expenses ...........     66,165,000      54,350,000      45,767,000
                                             ------------    ------------    ------------

Operating income .........................     51,389,000      42,578,000      32,978,000

Interest and other income ................        776,000         894,000       1,299,000
Interest expense .........................    (11,033,000)     (6,437,000)     (3,706,000)
                                             ------------    ------------    ------------

Income before minority
   interest and income taxes .............     41,132,000      37,035,000      30,571,000

Minority interest in net income ..........       (403,000)       (360,000)       (295,000)

Income tax provision .....................       (822,000)       (627,000)       (818,000)
                                             ------------    ------------    ------------

Net income ...............................     39,907,000      36,048,000      29,458,000

General partner's interest
   in net income .........................       (403,000)       (360,000)       (295,000)
                                             ------------    ------------    ------------
Limited partners' interest
   in net income .........................   $ 39,504,000    $ 35,688,000    $ 29,163,000
                                             ============    ============    ============

Allocation of net income per
   Senior Preference Unit and
   Preference Unit .......................   $       2.46    $       2.20    $       2.20
                                             ============    ============    ============

Weighted average number of Partnership
   units outstanding:
   Senior Preference Units ...............      7,250,000       7,250,000       7,250,000
   Preference Units ......................      4,650,000       5,400,000       5,650,000
</TABLE>


                See notes to consolidated financial statements.


                                     F-1
<PAGE>   33
                KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES
                          CONSOLIDATED BALANCE SHEETS


<TABLE>
<CAPTION>
                                                                      December 31,
                                                               ---------------------------
                                                                   1996           1995
                                                               ------------   ------------
<S>                                                            <C>            <C>         
                                    ASSETS

Current assets:
  Cash and cash equivalents ................................   $  8,196,000   $  6,307,000
  Accounts receivable ......................................     11,540,000     10,210,000
  Current portion of receivable from general partner .......        975,000      2,571,000
  Prepaid expenses .........................................      4,321,000      1,254,000
                                                               ------------   ------------
   Total current assets ....................................     25,032,000     20,342,000
                                                               ------------   ------------

Receivable from general partner, less current portion ......           --          974,000
                                                               ------------   ------------

Property and equipment .....................................    337,202,000    323,671,000
Less accumulated depreciation ..............................     87,469,000     77,200,000
                                                               ------------   ------------
   Net property and equipment ..............................    249,733,000    246,471,000
                                                               ------------   ------------
                                                               $274,765,000   $267,787,000
                                                               ============   ============

                       LIABILITIES AND PARTNERS' CAPITAL

Current liabilities:
  Current portion of long-term debt ........................   $  2,036,000   $  1,777,000
  Accounts payable .........................................      2,764,000      3,022,000
  Accrued expenses .........................................      4,355,000      3,293,000
  Accrued distributions payable ............................      9,833,000      9,016,000
  Accrued taxes, other than income taxes ...................      1,763,000      1,687,000
  Deferred terminaling fees ................................      2,874,000      2,634,000
  Payable to general partner ...............................        711,000        963,000
                                                               ------------   ------------
    Total current liabilities ..............................     24,336,000     22,392,000
                                                               ------------   ------------

Long-term debt, less current portion .......................    139,453,000    136,489,000
                                                               ------------   ------------

Other liabilities and deferred taxes .......................      6,612,000      7,160,000
                                                               ------------   ------------

Minority interest ..........................................      1,024,000        998,000
                                                               ------------   ------------

Partners' capital:
  Senior preference unitholders ............................     48,446,000     47,288,000
  Preference unitholders ...................................     37,982,000     37,239,000
  Preference B unitholders .................................      8,168,000      8,008,000
  Common unitholders .......................................      7,720,000      7,215,000
  General partner ..........................................      1,024,000        998,000
                                                               ------------   ------------
    Total partners' capital ................................    103,340,000    100,748,000
                                                               ------------   ------------

                                                               $274,765,000   $267,787,000
                                                               ============   ============
</TABLE>


                                     F-2

<PAGE>   34
                KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF CASH FLOWS




<TABLE>
<CAPTION>
                                                                      Year Ended December 31,
                                                            --------------------------------------------
                                                                1996            1995            1994
                                                            ------------    ------------    ------------
<S>                                                         <C>             <C>             <C>         
Operating activities:
  Net income ............................................   $ 39,907,000    $ 36,048,000    $ 29,458,000
  Adjustments to reconcile net income to net
    cash provided by operating activities:
    Depreciation and amortization .......................     10,981,000       8,261,000       7,257,000
    Minority interest in net income .....................        403,000         360,000         295,000
    Deferred income taxes ...............................        601,000         624,000         626,000
    Changes in working capital components:
      Accounts receivable ...............................     (1,330,000)     (4,605,000)     (1,101,000)
      Prepaid expenses ..................................     (3,067,000)        670,000        (257,000)
      Accounts payable and accrued expenses .............      1,697,000       1,943,000       1,241,000
      Deferred terminaling fees .........................        240,000         993,000          41,000
      Payable to general partner ........................       (252,000)        177,000         293,000
                                                            ------------    ------------    ------------

        Net cash provided by operating activities .......     49,180,000      44,471,000      37,853,000
                                                            ------------    ------------    ------------

Investing activities:
  Capital expenditures ..................................     (7,075,000)     (8,946,000)     (7,147,000)
  Acquisitions of pipelines and terminals ...............     (8,507,000)    (97,850,000)    (12,320,000)
  Other .................................................       (630,000)      2,429,000         203,000
                                                            ------------    ------------    ------------

        Net cash used by investing activities ...........    (16,212,000)   (104,367,000)    (19,264,000)
                                                            ------------    ------------    ------------

Financing activities:
  Changes in receivable from general partner ............      2,570,000       2,240,000       1,954,000
  Issuance of long-term debt ............................     73,000,000      96,500,000      41,350,000
  Payments of long-term debt ............................    (69,777,000)     (3,047,000)    (42,201,000)
  Distributions:
    Senior preference unitholders .......................    (16,313,000)    (15,950,000)    (15,950,000)
    Preference and Preference B unitholders .............    (12,712,000)    (12,430,000)    (12,308,000)
    Common unitholders ..................................     (7,110,000)     (4,582,000)     (1,738,000)
    General partner and minority interest ...............       (737,000)       (673,000)       (612,000)
                                                            ------------    ------------    ------------

        Net cash provided (used) by financing
         activities .....................................    (31,079,000)     62,058,000     (29,505,000)
                                                            ------------    ------------    ------------

Increase (decrease) in cash and cash equivalents ........      1,889,000       2,162,000     (10,916,000)

Cash and cash equivalents at beginning of period ........      6,307,000       4,145,000      15,061,000
                                                            ------------    ------------    ------------
Cash and cash equivalents at end of period ..............   $  8,196,000    $  6,307,000    $  4,145,000
                                                            ============    ============    ============

Supplemental information - Cash paid for interest .......   $ 10,368,000    $  5,479,000    $  3,470,000
                                                            ============    ============    ============
</TABLE>


                                     F-3

<PAGE>   35
                KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES
                  CONSOLIDATED STATEMENTS OF PARTNER'S CAPITAL





<TABLE>
<CAPTION>
                                   SENIOR
                                  PREFERENCE         PREFERENCE     PREFERENCE B      COMMON              GENERAL
                                 UNITHOLDERS        UNITHOLDERS     UNITHOLDERS     UNITHOLDERS           PARTNER         TOTAL
                                 ------------       ------------    ------------    ------------       ------------    ------------
<S>                              <C>                <C>             <C>             <C>                <C>             <C>         
Partners' capital at
 January 1, 1994 .............   $ 47,288,000       $ 45,247,000    $       --      $  7,060,000       $  1,003,000    $100,598,000

1994 income allocation .......     15,950,000         12,308,000            --           905,000            295,000      29,458,000

Distributions declared .......    (15,950,000)       (12,308,000)           --        (1,738,000)          (306,000)    (30,302,000)
                                 ------------       ------------    ------------    ------------       ------------    ------------

Partners' capital at
 December 31, 1994 ...........     47,288,000         45,247,000            --         6,227,000            992,000      99,754,000

Unit Conversion ..............           --           (8,008,000)      8,008,000            --                 --              --

1995 income allocation .......     15,950,000         11,880,000         550,000       7,308,000            360,000      36,048,000

Distributions declared .......    (15,950,000)       (11,880,000)       (550,000)     (6,320,000)          (354,000)    (35,054,000)
                                 ------------       ------------    ------------    ------------       ------------    ------------

Partners' capital at
 December 31, 1995 ...........     47,288,000         37,239,000       8,008,000       7,215,000            998,000     100,748,000

1996 income allocation .......     17,833,000         11,438,000       2,460,000       7,773,000            403,000      39,907,000

Distributions declared .......    (16,675,000)       (10,695,000)     (2,300,000)     (7,268,000)          (377,000)    (37,315,000)
                                 ------------       ------------    ------------    ------------       ------------    ------------

Partners' capital at
 December 31, 1996 ...........   $ 48,446,000       $ 37,982,000    $  8,168,000    $  7,720,000       $  1,024,000    $103,340,000
                                 ============       ============    ============    ============       ============    ============

Limited Partnership
 Units outstanding at
 January 1, 1994 .............      7,250,000          5,650,000            --         3,160,000                (a)      16,060,000

Unit Conversion in 1995 ......           --           (1,000,000)      1,000,000            --                 --              --
                                 ------------       ------------    ------------    ------------       ------------    ------------

Limited Partnership
 Units outstanding at
 December 31, 1995
 and 1996 ....................      7,250,000(b)       4,650,000       1,000,000       3,160,000                (a)      16,060,000
                                 ============       ============    ============    ============       ============    ============
</TABLE>

(a)  Kaneb Pipe Line Company owns a combined 2% interest in Kaneb Pipe Line
     Partners, L.P. as General Partner.
(b)  The Partnership Agreement allows for an additional issuance of up to 7.75
     million senior preference units.

                See notes to consolidated financial statements.


                                      F-4
<PAGE>   36

                KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1. PARTNERSHIP ORGANIZATION

        Kaneb Pipe Line Partners, L.P. (the "Partnership"), a master limited
   partnership, owns and operates a refined petroleum products pipeline
   business and a petroleum products and specialty liquids storage and
   terminaling business. The Partnership operates through Kaneb Pipe Line
   Operating Partnership, L.P. ("KPOP"), a limited partnership in which the
   Partnership holds a 99% interest as limited partner. Kaneb Pipe Line Company
   (the "Company"), a wholly-owned subsidiary of Kaneb Services, Inc.
   ("Kaneb"), as general partner holds a 1% general partner interest in both
   the Partnership and KPOP. The Company's 1% interest in KPOP is reflected as
   the minority interest in the financial statements.

        In September 1995, a subsidiary of the Company sold 3.5 million of the
   Preference Units ("PU") it held in a public offering and exchanged 1.0
   million of its PU's for 1.0 million Preference B Units, which are
   subordinate to the PU's until September 30, 1997.  At December 31, 1996, the
   Company owns an approximate 31% interest as a limited partner in the form of
   Preference Units, Preference B Units and Common Units, and as a general
   partner owns a combined 2% interest. The SPU's represent an approximate 44%
   interest in the Partnership and the 3.5 million publicly held Preference
   Units represent an approximate 22% interest. An approximate 1% ownership
   interest in the form of 61,700 PU's and 154,000 Common Units is held by
   officers of Kaneb.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

        The following significant accounting policies are followed by the
   Partnership in the preparation of the consolidated financial statements. The
   preparation of the Partnership's financial statements in conformity with
   generally accepted accounting principles requires management to make
   estimates and assumptions that effect the reported amounts of assets and
   liabilities and disclosures of contingent assets and liabilities at the date
   of the financial statements and the reported amounts of revenues and
   expenses during the reporting period. Actual results could differ from those
   estimates.

   CASH AND CASH EQUIVALENTS

        The Partnership's policy is to invest cash in highly liquid investments
   with maturities of three months or less, upon purchase. Accordingly,
   uninvested cash balances are kept at minimum levels. Such investments are
   valued at cost, which approximates market, and are classified as cash
   equivalents.  The Partnership does not have any derivative financial
   instruments.

   PROPERTY AND EQUIPMENT

        Property and equipment are carried at historical cost. Certain leases
   have been capitalized and the leased assets have been included in property
   and equipment. Additions of new equipment and major renewals and
   replacements of existing equipment are capitalized. Repairs and minor
   replacements that do not materially increase values or extend useful lives
   are expensed. Depreciation of property and equipment is provided on a
   straight-line basis at rates based upon expected useful lives of various
   classes of assets. The rates used for pipeline and storage facilities of
   KPOP are the same as those which have been promulgated by the Federal Energy
   Regulatory Commission.

   REVENUE AND INCOME RECOGNITION

        KPOP provides pipeline transportation of refined petroleum products and
   liquified petroleum gases. Revenue is recognized upon receipt of the
   products into the pipeline system.

        ST provides terminaling and other ancillary services. Fees are billed
   one month in advance and are reported as deferred income. Revenue is
   recognized in the month services are provided.

                                     F-5
<PAGE>   37

                KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


   ENVIRONMENTAL MATTERS

        The operations of the Partnership are subject to federal, state and
   local laws and regulations relating to protection of the environment.
   Although the Partnership believes its operations are in general compliance
   with applicable environmental regulations, risks of additional costs and
   liabilities are inherent in pipeline and terminal operations, and there can
   be no assurance significant costs and liabilities will not be incurred by
   the Partnership. Moreover, it is possible that other developments, such as
   increasingly stringent environmental laws, regulations and enforcement
   policies thereunder, and claims for damages to property or persons resulting
   from the operations of the Partnership, could result in substantial costs
   and liabilities to the Partnership.

        Environmental expenditures that relate to current operations are
   expensed or capitalized as appropriate. Expenditures that relate to an
   existing condition caused by past operations, and which do not contribute to
   current or future revenue generation, are expensed. Liabilities are recorded
   when environmental assessments and/or remedial efforts are probable, and the
   costs can be reasonably estimated. Generally, the timing of these accruals
   coincides with the completion of a feasibility study or the Partnership's
   commitment to a formal plan of action. The Partnership has recorded a
   reserve in other liabilities for environmental claims in the amount of $4.3
   million at December 31, 1996, including $3.5 million relating to the
   acquisitions of the West Pipeline and Steuart.

        The Company has indemnified the Partnership against liabilities for
   damage to the environment resulting from operations of the pipeline prior to
   October 3, 1989 (date of formation of the Partnership). The indemnification
   does not extend to any liabilities that arise after such date to the extent
   that the liabilities result from changes in environmental laws and
   regulations. In addition, ST's former owner has agreed to indemnify the
   Partnership against liabilities for damages to  the  environment  from
   operations conducted by the  former  owner prior  to  March 2,  1993. The
   indemnity, which expires March 1, 1998, is limited in amount to 60% of any
   claim exceeding $0.1 million, up to a maximum of $10 million.

   INCOME TAX CONSIDERATIONS

   Income before income tax expense is made up of the following components:


<TABLE>
<CAPTION>
                                                 Year Ended December 31,
                                      ------------------------------------------
                                          1996           1995           1994
                                      ------------   ------------   ------------
<S>                                   <C>            <C>            <C>         
Partnership operations ............   $ 37,950,000   $ 35,269,000   $ 28,156,000
Corporate operations ..............      2,779,000      1,406,000      2,120,000
                                      ------------   ------------   ------------
                                      $ 40,729,000   $ 36,675,000   $ 30,276,000
                                      ============   ============   ============
</TABLE>



        Partnership operations are not subject to federal or state income
   taxes. However, certain operations of ST are conducted through wholly-owned
   corporate subsidiaries which are taxable entities. The provision for income
   taxes for the periods ended December 31, 1996, 1995 and 1994 consists of
   deferred U.S. federal income taxes of $.7 million, $.6 million and $.6
   million, respectively, and current federal income taxes of $.2 million in
   1996 and 1994. The net deferred tax liability of $2.3 million and $1.7
   million at December 31, 1996 and 1995, respectively, consists of deferred
   tax liabilities of $7.4 million and $6.3 million, respectively, and deferred
   tax assets of $5.1 million and $4.6 million, respectively. The deferred tax
   liabilites consists primarily of tax depreciation in excess of book
   depreciation and the deferred tax assets consists primarily of net operating
   losses. The corporate operations have net operating losses for tax purposes
   totaling approximately $13.5 million which expire in years 2008 and 2011.

        Since the income or loss of the operations which are conducted through
   limited partnerships will be included in the tax returns of the individual
   partners of the Partnership, no provision for income taxes has been recorded
   in the accompanying financial statements on these earnings. The tax returns
   of the Partnership are subject to examination by federal and state taxing
   authorities. If any such examination results in adjustments to distributive
   shares of taxable income or loss, the tax liability of the partners would be
   adjusted accordingly.

                                     F-6

<PAGE>   38

                KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



        The tax attributes of the Partnership's net assets flow directly to
   each individual partner. Individual partners will have different investment
   bases depending upon the timing and prices of acquisition of partnership
   units. Further, each partner's tax accounting, which is partially dependent
   upon their individual tax position, may differ from the accounting followed
   in the financial statements. Accordingly, there could be significant
   differences between each individual partner's tax basis and their
   proportionate share of the net assets reported in the financial statements.
   Statement of Financial Accounting Standards No. 109, "Accounting for Income
   Taxes," requires disclosure by a publicly held partnership of the aggregate
   difference in the basis of its net assets for financial and tax reporting
   purposes. Management does not believe that, in the Partnership's
   circumstances, the aggregate difference would be meaningful information.

   ALLOCATION OF NET INCOME AND EARNINGS

        Net income is allocated to the limited partnership units in an amount
   equal to the cash distributions declared for each reporting period and any
   remaining income or loss is allocated to the class of units that did not
   receive the same amount of cash distributions per unit (if any). If the same
   cash distributions per unit are declared to all classes of units, income is
   allocated pro rata based on the aggregate amount of distributions declared.

        Earnings per SPU and PU are calculated by dividing the amount of net
   income allocated to the SPU's and PU's by the weighted average number of
   SPUs and PUs outstanding, respectively.

   CASH DISTRIBUTIONS

        The Partnership makes quarterly distributions of 100% of its Available
   Cash, as defined in the Partnership Agreement, to holders of limited
   partnership units ("Unitholders") and the Company. Available Cash consists
   generally of all the cash receipts of the Partnership plus the beginning
   cash balance less all of its cash disbursements and reserves. The
   Partnership expects to make distributions of Available Cash for each quarter
   of not less than $.55 per Unit (the "Minimum Quarterly Distribution"), or
   $2.20 per Unit on an annualized basis, for the foreseeable future, although
   no assurance is given regarding such distributions. The Partnership expects
   to make distributions of all Available Cash within 45 days after the end of
   each quarter to holders of record on the applicable record date.
   Distributions of $2.30, $2.20 and $2.20 per unit were declared to Senior
   Preference and Preference Unitholders in 1996, 1995 and 1994, respectively.
   During 1996, 1995 and 1994, the Partnership declared distributions of $2.30,
   $1.45 and $.55, respectively, per unit to the Common Unitholders. As of
   December 31, 1996, no arrearages existed on any class of partnership
   interest.

        Distributions by the Partnership of its Available Cash are made 99% to
   Unitholders and 1% to the Company, subject to the payment of incentive
   distributions to the General Partner if certain target levels of cash
   distributions to the Unitholders are achieved. The distribution of Available
   Cash for each quarter within the Preference Period, as defined, is subject
   to the preferential rights of the holders of the Senior Preference Units to
   receive the Minimum Quarterly Distribution for such quarter, plus any
   arrearages in the payment of the Minimum Quarterly Distribution for prior
   quarters, before any distribution of Available Cash is made to holders of
   Preference Units, Preference B Units or Common Units for such quarter. In
   addition, for each quarter within the Preference Period, the distribution of
   any amounts to holders of Common Units is subject to the preferential rights
   of the holders of the Preference B Units to receive the Minimum Quarterly
   Distribution for such quarter, plus any arrearages in the payment of the
   Minimum Quarterly Distribution for prior quarters. The Common Units are not
   entitled to arrearages in the payment of the Minimum Quarterly Distribution.
   In general, the Preference Period will continue indefinitely until the
   Minimum Distribution has been paid to the holders of the Senior Preference
   Units, the Preference Units, the Preference B Units and the Common Units for
   twelve consecutive quarters. The Minimum Quarterly distribution has been
   paid to all classes of Unitholders for all four quarters in 1996 and for the
   quarters ended September 30 and December 31, 1995. Prior to the end of the
   Preference Period, up to 2,650,000 of the Preference Units and the
   Preference B Units may be converted into Senior Preference Units on a
   one-for-one basis if the Third Target Distribution, as defined, is paid to
   all Unitholders for four full consecutive quarters. The Third Target
   distribution is reached when distributions of Available Cash equals $2.80
   per Limited Partner ("LP") Unit on an annualized basis. After the Preference
   Period ends all differences and distinctions between the three classes of
   units for the purposes of cash distributions will cease.

                                     F-7

<PAGE>   39

                KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


   CHANGE IN PRESENTATION

        Certain financial statement items have been reclassified to conform
   with the 1996 presentation.

3. ACQUISITIONS

        In February 1995, the Partnership acquired, through KPOP, the refined
   petroleum product pipeline assets (the "West Pipeline") of Wyco Pipe Line
   Company for $27.1 million plus transaction costs and the assumption of
   certain environmental liabilities. The West Pipeline was owned 60% by a
   subsidiary of GATX Terminals Corporation and 40% by a subsidiary of Amoco
   Pipe Line Company. The acquisition was financed by the issuance of $27
   million of first mortgage notes. The assets acquired from Wyco Pipe Line
   Company did not include certain assets that were leased to Amoco Pipe Line
   Company and the purchase agreement did not provide for either (i) the
   continuation of an arrangement with Amoco Pipe Line Company for the
   monitoring and control of pipeline flows or (ii) the extension or assumption
   of certain credit agreements that Wyco Pipe Line Company had with its
   shareholders.

        In December 1995, the Partnership acquired the liquids terminaling
   assets of Steuart Petroleum Company and certain of its affiliates
   (collectively, "Steuart") for $68 million plus transaction costs and the
   assumption of certain environmental liabilities. The acquisition price was
   initially financed by the issuance of a $68 million bank bridge loan which
   was refinanced during 1996 for $68 million of first mortgage notes. The
   asset purchase agreement includes a provision for an earn-out payment based
   upon revenues of one of the terminals exceeding a specified amount for a
   seven-year period beginning in January 1996.  No amount was payable under
   the earn-out provision in 1996.  The contracts also include a provision for
   the continuation of all terminaling contracts in place at the time of the
   acquisition, including those contracts with Steuart.

        The acquisitions have been accounted for using the purchase method of
   accounting. The total purchase price has been allocated to the assets and
   liabilities based on their respective fair values based on valuations and
   other studies.  Assuming the above acquisitions in 1995 occurred as of the
   beginning of the year ended December 31, 1995, the summarized unaudited pro
   forma revenues, net income and allocation of net income per SPU and PU for
   1995 would be $117.9 million, $35.7 million and $2.20, respectively.


4. PROPERTY AND EQUIPMENT

   The cost of property and equipment is summarized as follows:


<TABLE>
<CAPTION>
                                        Estimated
                                          Useful                December 31,
                                           Life      ---------------------------------
                                         (Years)         1996                 1995
                                       ------------  ------------          -----------
<S>                                       <C>        <C>                   <C>
Land ................................        -       $ 18,289,000         $  9,557,000
Buildings ...........................       35          6,442,000            5,134,000
Furniture and fixtures ..............       16          2,074,000            1,587,000
Transportation equipment ............        6          1,871,000            1,691,000
Machinery and equipment .............     20 - 40      34,945,000           33,465,000
Pipeline and terminating equipment ..     20 - 40     249,841,000          248,274,000
Pipeline equipment under                         
  capitalized lease .................     20 - 40      22,270,000           21,972,000
Construction work-in-progress .......        -          1,470,000            1,991,000
                                                     ------------         ------------

  Total                                              $337,202,000         $323,671,000
                                                     ============         ============
</TABLE>


                                     F-8

<PAGE>   40

                KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



5. LONG-TERM DEBT AND LEASES


<TABLE>
<CAPTION>
                                                             December 31,
                                                     ---------------------------
                                                         1996           1995
                                                     ------------   ------------
<S>                                                  <C>            <C>         
   First mortgage notes due 2001 and 2002 ........   $ 60,000,000   $ 60,000,000
   Bank bridge loan refinanced in 1996 ...........           --       68,000,000
   First mortgage notes due 2001 through 2016 ....     68,000,000           --
   Obligation under capital lease ................      8,489,000     10,266,000
   Revolving credit facility .....................      5,000,000           --
                                                     ------------   ------------

   Total long-term debt ..........................    141,489,000    138,266,000

   Less current portion ..........................      2,036,000      1,777,000
                                                     ------------   ------------

   Long-term debt, less current portion ..........   $139,453,000   $136,489,000
                                                     ============   ============
</TABLE>


        In 1994, a wholly-owned subsidiary of the Partnership issued $33
   million of first mortgage notes ("Notes") to a group of insurance companies.
   The Notes bear interest at the rate of 8.05% per annum and are due on
   December 22, 2001. Also in 1994, another wholly-owned subsidiary entered
   into a Restated Credit Agreement with a group of banks that provides a $15
   million revolving credit facility through January 31, 1998. The credit
   facility bears interest at variable interest rates and has a commitment fee
   of .2% per annum of the unused credit facility.  At December 31, 1996, $5.0
   million was drawn under the credit facility.  No amounts were drawn under
   the credit facility at December 31, 1995.  In 1995, the Partnership financed
   the acquisition of the West Pipeline with the issuance of $27 million of
   Notes due February 24, 2002 which bear interest at the rate of 8.37% per
   annum. The Notes and the credit facility are secured by a mortgage on
   substantially all of the pipeline assets of the Partnership and contain
   certain financial and operational covenants. The acquisition of the Steuart
   terminaling assets was initially financed by a $68 million bridge loan from
   a bank.  In June 1996, the Partnership refinanced this obligation with $68.0
   million of new first mortgage notes (the "Steuart notes") bearing interest
   at rates ranging from 7.08% to 7.98%.  $35 million of the Steuart notes is
   due June 2001, $8.0 million is due June 2003, $10.0 million is due June 2006
   and $15.0 million is due June 2016. The loan is secured, pari passu with the
   existing Notes and credit facility, by a mortgage on the East Pipeline.

        The following is a schedule by years of future minimum lease payments
   under capital and operating leases together with the present value of net
   minimum lease payments for capital leases as of December 31, 1996:


<TABLE>
<CAPTION>
                                                      Capital    Operating
  Year ending December 31:                            Lease (a)    Leases
                                                     ----------  ----------
<S>                                                  <C>           <C>     
     1997 .........................................  $3,080,000    $999,000
     1998 .........................................   7,198,000     898,000
     1999 .........................................        --       751,000
     2000 .........................................        --       658,000
     2001 .........................................        --       535,000
     Thereafter ...................................        --     2,176,000
                                                     ----------  ----------

     Total minimum lease payments .................  10,278,000  $6,017,000
                                                                 ==========

     Less amount representing interest ............   1,789,000
                                                     ----------

     Present value of net minimum lease payments ..   8,489,000
     Less current portion .........................   2,036,000
                                                     ----------

       Total obligation under capital lease,
         less current portion .....................  $6,453,000
                                                     ==========
</TABLE>


                                     F-9

<PAGE>   41

                KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



   (a)  The capital lease is secured by certain pipeline equipment and the
        Partnership has accrued its obligation to purchase this equipment for
        approximately $4.1 million at the termination of the lease.

        Total rent expense under operating leases amounted to $1.2, $.9 and $.9
   million for each of the years ended December 31, 1996, 1995 and 1994,
   respectively.

        KPOP and the Company entered into a payment priority agreement related
   to the capital lease obligation for pipeline equipment under which the
   Company is primarily liable for rental payments of approximately $2.9
   million per year through April 1997 and KPOP is primarily liable for the
   remaining rental payments. KPOP has recorded a receivable of $1.0 million at
   December 31, 1996 from the Company for the present value of these future
   lease payments. This receivable bears interest at an annual rate of 13.8%,
   which reflects the imputed interest rate on the capital lease. KPOP recorded
   interest income of $.3 million, $.7 million and $.9 million from the Company
   on this receivable balance for the periods ended December 31, 1996, 1995 and
   1994, respectively. The amount of the capital lease obligation that exceeds
   the receivable from the Company ($7.5 million at December 31, 1996)
   represents the present value of the lease obligation and purchase option due
   subsequent to April 1997.

        The estimated fair value of all long term debt (excluding capital
   leases) as of December 31, 1996 was approximately $134 million as compared
   to the carrying value of $133 million.  These fair values were estimated
   using discounted cash flow analysis, based on the Partnership's current
   incremental borrowing rates for similar types of borrowing arrangements.
   The Partnership has not determined the fair value of its capital leases as
   it is not practicable.  These estimates are not necessarily indicative of
   the amounts that would be realized in a current market exchange.  The
   Partnership has no derivative financial instruments.

6. RELATED PARTY TRANSACTIONS

        The Partnership has no employees and is managed and controlled by the
   Company. The Company and Kaneb are entitled to reimbursement of all direct
   and indirect costs related to the business activities of the Partnership.
   These costs, which totaled $10.5 million, $9.5 million and $9.0 million for
   the years ended December 31, 1996, 1995 and 1994, respectively, include
   compensation and benefits paid to officers and employees of the Company and
   Kaneb, insurance premiums, general and administrative costs, tax information
   and reporting costs, legal and audit fees. Included in this amount is $8.4
   million, $7.7 million and $7.0 million of compensation and benefits,
   including pension costs, paid to officers and employees of the Company for
   the periods ended December 31, 1996, 1995 and 1994, respectively, which
   represent the actual amounts paid by the Company or Kaneb. In addition, the
   Partnership paid $.2 million during each of these respective periods for an
   allocable portion of the Company's overhead expenses. At December 31, 1996
   and 1995, the Partnership owed the Company $.7 million and $1.0 million,
   respectively, for these expenses which are due under normal invoice terms.


                                    F-10

<PAGE>   42

                KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




7. QUARTERLY FINANCIAL DATA (UNAUDITED)


   Quarterly operating results for 1996 and 1995 are summarized as follows:

<TABLE>
<CAPTION>
                                           Quarter Ended
                       ---------------------------------------------------------
                         March 31,      June 30,     September 30,  December 31,
                       ------------   ------------   ------------   ------------
<S>                    <C>            <C>            <C>            <C>         
1996:
 Revenues ..........   $ 27,826,000   $ 28,795,000   $ 29,963,000   $ 30,971,000
                       ============   ============   ============   ============

 Operating income ..   $ 11,600,000   $ 12,841,000   $ 12,832,000   $ 14,116,000
                       ============   ============   ============   ============

 Net income ........   $  8,677,000   $ 10,007,000   $  9,872,000   $ 11,351,000
                       ============   ============   ============   ============

 Allocation of net
  income per
  SPU and PU .......   $        .55   $        .62   $        .61   $        .70
                       ============   ============   ============   ============

1995:
 Revenues ..........   $ 20,382,000   $ 23,342,000   $ 26,533,000   $ 26,671,000
                       ============   ============   ============   ============

 Operating income ..   $  8,626,000   $ 10,097,000   $ 10,863,000   $ 12,992,000
                       ============   ============   ============   ============

 Net income ........   $  7,299,000   $  8,458,000   $  9,209,000   $ 11,082,000
                       ============   ============   ============   ============

 Allocation of net
  income per
  SPU and PU .......   $        .55   $        .55   $        .55   $        .55
                       ============   ============   ============   ============
</TABLE>



                                    F-11
<PAGE>   43

                KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


8. BUSINESS SEGMENT DATA

   Selected financial data pertaining to the operations of the Partnership's
   business segments is as follows:


<TABLE>
<CAPTION>
                                                       Year Ended December 31,
                                              ------------------------------------------
                                                  1996           1995           1994
                                              ------------   ------------   ------------
<S>                                           <C>            <C>            <C>         
Revenues:
 Pipeline operations ......................   $ 63,441,000   $ 60,192,000   $ 46,117,000
 Terminaling operations ...................     54,113,000     36,736,000     32,628,000
                                              ------------   ------------   ------------

                                              $117,554,000   $ 96,928,000   $ 78,745,000
                                              ============   ============   ============

Operating Income:
 Pipeline operations ......................   $ 32,221,000   $ 29,747,000   $ 21,156,000
 Terminaling operations ...................     19,168,000     12,831,000     11,822,000
                                              ------------   ------------   ------------
                                              $ 51,389,000   $ 42,578,000   $ 32,978,000
                                              ============   ============   ============

Depreciation and Amortization:
 Pipeline operations ......................   $  4,817,000   $  4,843,000   $  4,276,000
 Terminaling operations ...................      6,164,000      3,418,000      2,981,000
                                              ------------   ------------   ------------
                                              $ 10,981,000   $  8,261,000   $  7,257,000
                                              ============   ============   ============

Capital Expenditures (including capitalized
 leases and excluding acquisitions):
 Pipeline operations ......................   $  3,446,000   $  3,381,000   $  2,237,000
 Terminaling operations ...................      3,629,000      5,565,000      4,951,000
                                              ------------   ------------   ------------
                                              $  7,075,000   $  8,946,000   $  7,188,000
                                              ============   ============   ============

Identifiable assets:
 Pipeline operations ......................   $102,391,000   $105,464,000   $ 75,739,000
 Terminaling operations ...................    172,374,000    162,323,000     87,366,000
                                              ------------   ------------   ------------
                                              $274,765,000   $267,787,000   $163,105,000
                                              ============   ============   ============
</TABLE>


                                    F-12

<PAGE>   44


                       REPORT OF INDEPENDENT ACCOUNTANTS

To the Partners of
Kaneb Pipe Line Partners, L.P.

In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) and (2) on page 30 present fairly, in all
material respects, the financial position of Kaneb Pipe Line Partners, L.P. and
its subsidiaries  (the "Partnership") at December 31, 1996 and 1995, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1996, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Partnership's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.

PRICE WATERHOUSE LLP

Dallas, Texas
February 20, 1997


                                    F-13

<PAGE>   45

                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, Kaneb Pipe Line Partners, L.P. has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.


                                        KANEB PIPE LINE PARTNERS, L.P.

                                        By: Kaneb Pipe Line Company
                                            ----------------------------
                                            General Partner


                                        By: EDWARD D. DOHERTY
                                            ----------------------------
                                            Chairman of the Board and
                                            Chief Executive Officer
                                            Date: March 24, 1997


     Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of Kaneb
Pipe Line Partners, L.P. and in the capacities with Kaneb Pipe Line Company and
on the date indicated.



<TABLE>
<CAPTION>
        SIGNATURE                         TITLE                    DATE
        ---------                         -----                    ----
<S>                             <C>                           <C>
Principal Executive Officer

    EDWARD D. DOHERTY           Chairman of the Board         March 24, 1997 
----------------------------    and Chief Executive Officer

Principal Accounting Officer

    JIMMY L. HARRISON           Controller                    March 24, 1997
----------------------------                                                
                                                                            
Directors                                                                   
                                                                            
       SANGWOO AHN              Director                      March 24, 1997
----------------------------                                                
                                                                            
     JOHN R. BARNES             Director                      March 24, 1997
----------------------------                                                
                                                                            
       M.R. BILES               Director                      March 24, 1997
----------------------------                                                
                                                                            
     CHARLES R. COX             Director                      March 24, 1997
----------------------------                                                
                                                                            
    EDWARD D. DOHERTY           Director                      March 24, 1997
----------------------------                                                
                                                                            
   FRANK M. BURKE, JR.          Director                      March 24, 1997
----------------------------                                                
                                                                            
      RALPH A. REHM             Director                      March 24, 1997
----------------------------

     JAMES R. WHATLEY           Director                      March 24, 1997
----------------------------
</TABLE>








<PAGE>   46
                                 EXHIBIT INDEX


<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                 DESCRIPTION
-------   ---------------------------------------------------------------------
 <S>      <C>
  3.1     Amended and Restated Agreement of Limited Partnership dated September
          27, 1989, filed as Appendix A to the Registrant's Prospectus, dated
          September 25, 1989, in connection with the Registrant's Registration
          Statement on Form S-1 (S.E.C. File No. 33-30330) which exhibit is
          hereby incorporated by reference.

 10.1     ST Agreement and Plan of Merger date December 21, 1992 by and between
          Grace Energy Corporation, Support Terminal Services, Inc., Standard
          Transpipe Corp., and Kaneb Pipe Line Operating Partnership, NSTS,
          Inc. and NSTI, Inc. as amended by Amendment of STS Merger Agreement
          dated March 2, 1993. Filed as Exhibit 10.1 of the exhibits to
          Registrant's current Report on Form 8-K, dated March 16, 1993, which
          exhibit is hereby incorporated by reference.

 10.2     Restated Credit Agreement between Kaneb Operating Partnership, L.P.
          ("KPOP"), Texas Commerce Bank, N.A., ("TCB"), and certain other
          Lenders, dated December 22, 1994, filed as Exhibit 10.13 of the
          exhibits to the Registrant's 1994 Form 10-K, which exhibit is hereby
          incorporated by reference.

 10.3     Pledge and Security Agreement between Kaneb Pipe Line Company ("KPL")
          and TCB, dated October 11, 1993, filed as Exhibit 10.3 of the
          exhibits to the Registrant's 1993 Form 10-K, which exhibit is hereby
          incorporated by reference.

 10.4     Note Purchase Agreement, dated December 22, 1994 (the "1994 Note
          Purchase Agreement"), filed as Exhibit 10.2 of the exhibits to
          Registrant's Current Report on Form 8-K, dated March 13, 1995 (the
          "March 1995 Form 8-K"), which exhibit is hereby incorporated by
          reference.

 10.5     Note Purchase Agreements, dated June 27, 1996, filed herewith.

 10.6     Agreement for Sale and Purchase of Assets between Wyco Pipe Line
          Company and KPOP, dated February 19, 1995, filed as Exhibit 10.1 of
          the exhibits to the Registrant's Registrant's report on Form 8-K
          filed with the Securities and Exchange Commission on March 13, 1995,
          and said exhibit is hereby incorporated by reference.

 10.7     Asset Purchase Agreements between and among Steuart Petroleum
          Company, SPC Terminals, Inc., Piney Point Industries, Inc., Steuart
          Investment Company, Support Terminals Operating Partnership, L.P. and
          KPOP, as amended, dated August 27, 1995. Said documents are on file
          as Exhibits 10.1, 10.2, 10.3, and 10.4 of the exhibits to
          Registrant's current report on Form 8-K dated January 3, 1996, and
          said exhibits are hereby incorporated by reference.

 21       List of Subsidiaries, filed herewith.

 24.1     Powers of Attorney, not applicable.

 27       Financial Data Schedule, filed herewith.
</TABLE>